By Gertrude Chavez-Dreyfuss
NEW YORK (Reuters) – Bond investors, worried about persistently sticky inflation, have reduced their exposure to longer-dated U.S. Treasuries ahead of the Federal Reserve’s two-day monetary policy meeting this week in which it is likely to hold interest rates steady.
The U.S. central bank’s policy-setting Federal Open Market Committee is widely expected on Wednesday to keep its benchmark overnight interest rate in the 5.25%-5.50% range for a seventh consecutive meeting. In his press conference after the end of the meeting, Fed Chair Jerome Powell is expected to continue emphasizing an easing bias, although he is likely to show little urgency to cut rates in the near term given persistent inflationary pressures and a still robust labor market.
The U.S. rate futures market has scaled back expectations for policy easing this year and is now pricing in one 25 basis-point rate cut in 2024, most likely in November or December, according to LSEG calculations.
Investors will also focus on the Fed’s updated quarterly economic projections, including interest rate forecasts, referred to as the “dot plot.” The last dot plot in March pointed to three rate cuts in 2024. Market participants expect that to be whittled down to two cuts or one.
“We are underweight the longer end of the (Treasuries) curve, in particular 20- to 30-year maturities ahead of the Fed meeting,” said Noah Wise, senior portfolio manager for the Plus Fixed Income team at Allspring Global Investments, with assets under management of $570 billion.
“That’s where we see more of the risk because inflation is structurally higher. The services side of the economy continues to run hotter than the goods side. And what we’ve seen in our analysis indicates that those price changes tend to be stickier.”
Higher growth and inflation expectations typically prompt a sell-off on the long end of the curve, pushing those yields higher.
Inflation overall has moderated but remains above the Fed’s 2% target. The personal consumption expenditures (PCE) price index, the Fed’s preferred measure of inflation, rose 2.7% in April on a year-on-year basis, while the consumer price index (CPI) posted an annual rise of 3.4% in April.
CPI data for May is due to be released on Wednesday.
Wage inflation also increased last month. Average hourly earnings rose 0.4% while wages increased 4.1% in the 12 months through May. Annual wage growth in the 3.0%-3.5% range is viewed as consistent with the Fed’s 2% inflation goal.
Boris Kovacevic, global macro strategist at global payments company Convera, said there are signs price pressures could remain elevated as goods inflation has started to pick up again with the rise in commodity prices.
FADING LONG BETS
Going into this week’s Fed meeting, bond investors have been paring their net long positions on Treasuries with longer maturities in the futures market.
Data from the Commodity Futures Trading Commission showed money managers reduced net long positions on U.S. 10-year note futures last week to 1,214,934 contracts, the lowest in about two months. Net longs on this maturity have been falling since the first week of May.
They also curbed net longs on ultra-long U.S. bond futures to 724,972, the smallest in 1-1/2 months. Their net longs have been decreasing since May 14.
“The challenge for everyone trying to invest in these markets is that with the yield-curve shape like it is, any long-duration positions are negative carry in the sense that cash rates (money market funds) are north of 5%, while bond yields are below 5%,” said Brendan Murphy, head of fixed income for North America at Insight Investment, which oversees $825.3 billion in assets.
“So any time you extend your duration, essentially you’re giving up some yield to do that.”
Extending duration implies buying more long-dated assets.
In contrast, fixed-income investors have been generally long on the shorter-end, particularly U.S. 2-year to 5-year Treasuries, or the so-called belly of the curve, the sectors likely to outperform the long end when the Fed cuts rates.
Institutional investors increased net longs on U.S. 2-year note futures in the week ended June 4, data showed. Those net longs have increased for two straight weeks.
Asset managers also have remained net long on U.S. 5-year note futures, hitting a record high in late May before tapering off a little bit last week.
“Investors think the front end of the curve has peaked and the Fed is not going to need to raise interest rates again. That should hold the front end relatively steady,” said Chip Hughey, managing director of fixed income at Truist Advisory Services.
(Reporting by Gertrude Chavez-Dreyfuss; Editing by Alden Bentley and Paul Simao)
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