Traders are coming to terms with Jerome Powell’s tone.
by Michael Mackenzie, Ye Xie and Alice Gledhill
Bond investors are coming to terms with Jerome Powell’s message that the Federal Reserve is in no-rush to start cutting interest rates.
After Powell reiterated the central bank’s wait-and-see approach to easing monetary policy last week, traders aggressively boosted bets that the benchmark lending rate will be cut by less than a three-quarter point in 2025, with the first move starting only in July.
Whether the wager holds will depend on the trajectory of the US economy and inflation in the coming weeks. Details on the trade talks between US and China this weekend and a reading on consumer prices on Tuesday may have investors stepping back from their latest views. Powell said as policymakers look for more clarity on tariff policies, the risks of higher inflation and unemployment have increased due to President Donald Trump’s sweeping levies.
“The bond market’s accepting the fact that inflation is going to be higher than kind of initially anticipated, and that is a complicating factor for investors’ belief that the Fed will step in and cut rates,” said Greg Peters, who helps manage more than $850 billion as co-chief investment officer at PGIM Fixed Income.
Options traders are piling into more hedges to protect against the Fed potentially not easing this year, with one growing position that anticipates the central bank won’t cut rates in 2025. Before the latest jobs data showed resilient hiring in April, swaps had indicated strong odds for a rate cut as soon as next month.
Meanwhile, Wall Street’s calls of zero to as much as a 1.25 point rate-cut this year also highlight the uncertainty around the Fed’s policy path. Several big bank economists forecast either two or three reductions this year, beginning in July or September.
“The market’s pricing of rate cuts is quite overdone. Absent a recession the Fed will only cut rates 25 basis points more,” said Sonal Desai, chief investment officer for fixed income at Franklin Templeton. Treasury yields are rangebound as the market waits for more clarity on trade policy, “which I don’t think we’ll get for a rather extended period,” she added.
The two-year Treasury yield, more sensitive to Fed policy expectations, climbed 33 basis points from this month’s low of 3.55%. The move extended at the end of the week as the US and UK announced a trade deal, boosting risk appetite, and as Trump hinted at lower tariffs for China if talks progress.
Traders as well as policymakers are taking some comfort in long-dated expectations of inflation remaining within range even as surveys have shown a spike around tariff announcements. The latest New York Fed survey of one-year inflation expectations rose to a fresh peak since 2023, while a three-year measure climbed to its highest level since 2022.
Consumer price index data for April is forecast to rebound from March and rise by 0.3% on the month, according to estimates compiled by Bloomberg.
“The most frustrating thing at this point in time is the data — on jobs and inflation — we’re getting is actually backward looking,” said John Madziyire, senior portfolio manager at Vanguard, adding that it won’t be until possibly July will the data include the tariff impact.
His firm prefers owning five- to seven-year Treasuries “because clearly the Fed is not going to be proactively cutting rates.”
Michael Krautzberger, global CIO fixed income at Allianz Global Investors, said the central bank will ultimately prioritize supporting the labor market, so long as it’s confident that rising prices are chiefly the result of tariffs. While a spike in inflation may prove short-lived, the Fed will be wary of a potentially protracted impact on employment and growth, he said.
“Powell specifically said that it’s difficult to be preemptive and I think that is the main takeaway with this particular policy mix of tariffs and the potential impact to inflation and growth leads the Fed needing to see more information,” said David Rogal, portfolio manager, fundamental fixed income group at BlackRock.
“If you get a significant rise in unemployment and inflation is still running above target, the market view is that the Fed would prioritize stabilizing US growth over inflation.” Rogal added.
- Economic data:
- May 12: Federal budget balance
- May 13: NFIB small business optimism; consumer price index, real average hourly earnings
- May 14: MBA mortgage applications
- May 15: Retail sales; producer price index; initial jobless claims; Philadelphia Fed business outlook; industrial production; capacity utilization; manufacturing (SIC) production; business inventories; NAHB housing price index
- May 16: Housing starts; building permits; important and export price index; New York Fed services business activity; University of Michigan consumer sentiment and inflation expectations; net long-term TIC flows
- Fed calendar:
- May 12: Fed Governor Adriana Kugler
- May 14: Fed Governor Christopher Waller; Fed Vice-Chair Philip Jefferson; San Francisco Fed President Mary Daly
- May 15: Fed Chair Jerome Powell
- May 16: Daly; Richmond Fed President Tom Barkin
- Auction calendar:
- May 12: 13-, 26-week bills
- May 13: 6-week and 52-week bills
- May 14: 17-week bills
- May 15: 4-, 8-week bills
