Signs of exhaustion are emerging in the U.S. bond market after its biggest weekly rally since August.
U.S. Treasuries weakened in a volatile trading session on Monday, with yields across all maturities briefly higher by at least 15 basis points. While the moves have since mellowed, they still mark a stark turnaround from declines earlier in the session.
Traders' bets on how much the Federal Reserve will lower interest rates this year also fluctuated between three and five quarter-point cuts. Four reductions are now reflected in overnight interest-rate swaps this year, with the first fully priced in for June — and only a very small chance that the central bank steps in before its next scheduled policy meeting.
Fear of a global recession triggered by the U.S. administration's tariffs — and uncertainty around whether some of the most severe levies may be open for negotiation — led to sharp swings in the bond market as the week kicked off. While U.S. President Donald Trump touted talks with Japanese officials, the White House denied to CNBC any plans to pause tariffs for 90 days.
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Yields on U.S. 30-year bonds had fallen as low as 4.32% earlier in the session, then shot higher to 4.62%. They now trade around 15 basis points higher on the day at 4.56%.
"From our perspective, it is a question of do we take some profits or let it run," said Daniel Loughney, head of fixed income at Mediolanum International Funds Ltd. "Markets are structurally intact, at the moment. We are watching things very carefully and if Trump maintains the mantra then I suspect things will get worse."
For traders wagering on the Fed's reaction to the uncertainty, it's a question of how severely a trade war will impact inflation and the economy. Bill Dudley, a Bloomberg Opinion columnist and former New York Fed president, said on Monday that stagflation has become the U.S.'s best-case scenario.
Emergency interest-rate cuts are highly unusual and last employed by the Fed as the coronavirus outbreak roiled markets in early 2020. Traders briefly anticipated an inter-meeting cut in August when stocks fell sharply amid an unwind of the yen carry-trade, but policymakers held firm.
Late last week, open interest in the April fed funds futures soared, with volumes Thursday ending at a record high. At least one large block trade stands to benefit from a potential Fed policy move before the next scheduled meeting, based on the expiry date of the contract.
Recession incoming
In recent days, JPMorgan Chase said it expects the U.S. economy to fall into a recession this year. Chief Economist Michael Feroli sees the Fed cutting in June, with moves at each subsequent meeting through January. The bank's chief executive officer Jamie Dimon weighed in early Monday,
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Economists at Goldman Sachs Group also changed their forecasts last week, with three reductions now the base case for both the Federal Reserve and the European Central Bank.
What Bloomberg strategists say...
"The Federal Reserve may soon not have a choice but to cut rates. Tariffs raise the ugly scepter of inflation, true, but if growth turns pear-shaped, the Fed will have no choice but to prioritize the economy."— Ven Ram, macro strategist, Dubai.
Governments around the world are rushing to negotiate with U.S. officials to reduce the tariffs imposed on their exports, leaving markets in freefall as traders price in the uncertainty of whether deals can be struck.
Traders have also slashed rate-cut bets for the ECB and Bank of England on expectations policymakers will have to act to shield their economies.
To be sure, Fed Chair Jerome Powell made clear on Friday that he would not rush to ease rates even as turmoil erupts across markets. In a speech, he stressed that still-elevated inflation means policymakers will need to act with caution given the temporary price boost from tariffs.
Wrightson ICAP economist Lou Crandall said a chance of a cut at or before the May 7 meeting remains, in his view, below 50%, suggesting policymakers would be wary of triggering a further bout of panic.
"A preemptive rate cut would only be helpful if it bolstered business confidence, and that might not be the case if it were seen as a crisis response," he wrote in a note.
