‘Worst case’ inflation fears threaten bond market calm

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By David Randall and Davide Barbuscia

NEW YORK- An uneasy calm that has pervaded the bond market could break in coming days, as looming data on employment and consumer prices shed more light on how long the Federal Reserve might need to keep rates elevated in its battle to decisively defeat inflation.

While investors still expect rate cuts this year, unexpected economic strength has forced many to recalibrate how deeply the Fed will be able to lower borrowing costs without reigniting inflation, aligning the market’s views on easing more closely with those of the central bank. Yields on the benchmark US 10-year Treasury, which move inversely to bond prices, have traded in a narrower range over the last few weeks.

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Fed Chairman Jerome Powell echoed that sentiment on Wednesday, when he told lawmakers that continued progress on lowering inflation “is not assured” though the central bank still expects to cut rates in 2024.

Things could grow more precarious for bond investors if Friday’s employment data and next week’s consumer prices report show continued strength in the economy and more stickiness in inflation, further pushing back expectations for Fed cuts. That, in theory, could drive yields higher, further hurting investors who had jumped into Treasuries over the last few months betting on imminent easing.

“The worst case scenario for the fixed income market is if we get a ‘no-landing’ scenario, where the economic picture is still solid and inflation picks up,” said Lawrence Gillum, chief fixed income strategist for LPL Financial. “If we get that reacceleration in inflation or the economy, the 10-year could retest 5 percent ”, he said.

In his remarks, Powell noted that inflation had “eased substantially” since hitting 40-year highs in 2022. He said there were risks of both cutting rates too soon and allowing inflation to reaccelerate, and of keeping monetary policy too tight for too long and damaging an ongoing economic expansion.

The 10-year yield was recently at 4.11 percent , little changed after Powell’s comments. Yields have bounced between about 4.05 percent  and 4.35 percent  since early February, following a swift decline from a 16-year high of just above 5 percent  hit in October 2023.

That range of just over 30 basis points compares to a 38 basis point range from the start of the year through the first two trading days of February, and an almost 57 point swing in December.

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