Sep 09, 2016 | Post by: Roman Chuyan, CFA Comments Off on What’s Next For Bonds?

What’s Next For Bonds?

In their speeches during and after the annual retreat in Jackson Hole on Aug 25-27, Federal Reserve officials sounded more hawkish than most observers expected. Fed Chair Janet Yellen said that the case to raise interest rates is getting stronger as the U.S. economy approaches the Fed’s goals:

In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months.

Labor market numbers have in fact been strong, with unemployment at 4.9% and private payrolls rising by an average of 230,000 a month in the past three months. August payroll growth of 151,000 (see chart) came in below consensus, but “good enough” to still warrant a rate increase by the Fed, according to some observers. The odds of a rate hike this month rose to about 30%, and about 60% chance of a hike this year.

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The expectation of the Fed action, and the ECB’s lack of additional stimulus, are pushing global yields somewhat higher (bond prices lower). The 2y Treasury yield rose to 0.78% (from a mid-July low of 0.6%), and the 10y yield rose to 1.67% today, the highest since June. The stock market also began to drop – the S&P 500 is down 2.4% today.

What happens next depends heavily on inflation numbers, as I wrote previously. If PPI/CPI inflation statistics show any kind of strength this month, the odds will jump that the Fed delivers a rate increase (it may or may not be 25 basis points) as soon as at the FOMC next meeting on Sep 21. If this occurs, expect a jump in interest rates and a corresponding decline in long-term bond prices, stocks, and other risk assets.

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