Bond traders focus on Trump rather than Fed cuts

by Liz Capo McCormick

Bond traders looking for Jerome Powell to reignite a rally came away disappointed after the Federal Reserve cut interest rates as expected but gave little away about the path ahead.

Treasuries inched higher, adding to gains clocked Thursday. The 10-year yield edged down two basis points to 4.31%, taking the drop this week to eight basis points. That’s the biggest decline since September on a closing basis and comes despite sharp losses triggered after Donald Trump was elected to the presidency.

Yet few saw the dip as the beginning of a new trend lower. That’s because Trump is expected to push through higher tariffs, lower taxes and looser regulation — all of which could fan inflation by pouring fuel on an already strong economy. It would certainly drive up the deficit and test the market’s ability to absorb a seemingly endless supply of Treasuries.

Powell underscored those deficit concerns, saying the federal government’s fiscal policy is on an “unsustainable path” even as he declined to comment on how Trump’s plans may affect the outlook. The Fed chief also did little to provide clarity around the FOMC’s next meeting in December, leaving swaps traders pricing in a roughly 70% chance of another cut then.

“I don’t think the statement or anything Powell said really moved against the recent bond market re-pricing,” said Lawrence Gillum, the chief fixed-income strategist at LPL Financial. 

“He did leave the door open enough to suggest that if the data is stronger than expected they could skip December,” he said. “We are going to stay at these yields levels for the time being.”

Traders have dialed back their expectations for how deeply the Fed will cut its benchmark rate next year since a run of strong economic data and the election altered the outlook. Swaps traders see the Fed’s target band — which was just lowered to 4.50%-4.75% — falling to around 3.7% in a year’s time. As recently as a month ago, the expectation priced into the swap contracts was for a drop to about 3%.

In the statement issued after Thursday’s Fed meeting, policymakers no longer included a line about achieving “greater confidence” that inflation is moving sustainably toward 2%, though they noted it has “made progress” toward the central bank’s goal.  

Omair Sharif, president of Inflation Insights, saw that change as “cracking open the door to a December pause,” though the market still widely expects another downward move.

“With additional inflation and employment data in, the Fed went 25 basis points as expected,” said Whitney Watson, global co-head and co-chief investment officer of fixed income and liquidity solutions at Goldman Sachs Asset Management. “We expect the same to occur in December. However, stronger data and uncertainty over fiscal and trade policies mean rising risks that the Fed may opt to slow the pace of easing.”

Despite the Fed’s rate cuts at the last two meetings, 10-year Treasury yields have moved up, rising from as low as about 3.6% in mid-September. They were catapulted higher at first by key economic data that proved better than expected, then by so-called Trump trades as the odds of his election seemingly improved.

Powell brushed aside questions about whether the moves — by effectively raising interest rates in the financial system — would alter the trajectory of its policy. 

“We’ve watched the run-up in bond rates and it’s nowhere near where it was, of course, a year ago,”  Powell told reporters after the rate decision. “So we’re watching that. Things have been moving around and we’ll see where they settle. I think it’s too early to really say where they settle.”

Two-year yields, more closely tied than longer maturities to the outlook for central bank policy, finished on Thursday down six basis points at 4.20%.

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