Federal Reserve Chair Jerome Powell's recent emphasis on job market protection is prompting many bond traders to anticipate sustained inflation rates. This shift in focus has led to increased interest in inflation-linked securities, as traders bet on their outperformance against standard Treasuries.
Tim Magnusson of Garda Capital Partners highlighted Powell's support for "being long breakevens," a strategy that benefits from inflation. In a recent press briefing, Powell underscored the possibility of reducing interest rates in response to unexpected unemployment spikes. The Fed's forecasts now include quicker inflation and growth for 2024 while predicting three rate cuts.
According to Magnusson, this indicates the Fed's tolerance for slightly higher inflation levels. Echoing this sentiment, Bank of America Corp. strategists recommend investing in 30-year breakevens, pointing to a Fed inclined towards rate cuts amidst rising inflation expectations.
The breakeven market reflects growing inflation expectations, with the five-year breakeven rate currently at about 2.43%, a significant increase from its December low. Swaps traders, however, have recently scaled back their bets on an imminent Fed rate cut following comments from Fed Governor Christopher Waller, who advised a cautious approach to rate reductions.
Waller's remarks suggest that the Fed might delay or minimize rate cuts based on recent economic data. This cautious stance comes amid rising breakeven rates and a potential steepening in the yield curve, as investors speculate on the performance of longer-term Treasuries in an environment of persistent inflation.
Survey-based inflation expectations also indicate a quicker pace of price increases, with consumers predicting an average inflation rate of 2.9% over the next five to ten years. The Fed's projections show the PCE price index exceeding their 2% target for the next two years, with core inflation expected to rise.
Powell acknowledged the current data, which shows faster price gains than anticipated, but emphasized the need for data confirming a sustainable move towards the 2% inflation target. The upcoming PCE price report is predicted to show a core monthly increase of 0.3%, challenging the Fed's target.
Experts like Jim Bianco warn of the risks associated with rate cuts amidst high inflation, suggesting that it could lead to higher yields. Powell's recent statements suggest a longer timeframe for inflation to decrease towards 2%, as the Fed now prioritizes unemployment rates over inflation concerns.
