Bond Traders Return to Familiar Turf

(Bloomberg View) -- The U.S. Treasury market has been buffeted by various geopolitical crises, the French elections, and uncertainty over the Trump administration's tax cuts and reform. This week, things should get back to some semblance of normality with a slew of key economic data on the schedule as well as a Federal Reserve monetary policy meeting.

So, what can bond traders expect? The data this week should look a bit brighter than Friday's soggy gross domestic product report, which showed the economy grew at a 0.7 percent annual rate in the first quarter, the slowest pace in three years. Today, the ISM manufacturing index is likely to hold well above the 50 level that signals expansion. The week ends with the government's monthly employment report, which is forecast to show that jobs creation rebounded sharply from last month's weak 98,000 gain to something closer to trend at 200,000.

In between, Fed policy makers meet to decide interest rates on May 3. The central bank has largely been sidelined as a key market influence since its assertive March rate hike. Since then, officials have been reduced to providing plaintive reminders that their three-hike scenario for 2017 program is still very much on track, despite the economic swings. For now, the market and the Fed are willing to look through the first-quarter GDP report, as it just continues a trend in recent years of sluggish growth early on before things pick up starting in the second quarter. The likelihood of a big rebound in consumption and inventories is penciled in for the second quarter, with GDP estimates centered around 2.5 percent to 3 percent.

Even though the bond market has staged an impressive rally in recent weeks, no change in rates is expected this week. However, the wording of the statement issued after the meeting of the Federal Open Market Committee could offer new clues as to the Fed's views as there is no press conference scheduled with Chair Janet Yellen. Strong growth in the second half of last year after the short-term turbulence around the U.K. Brexit vote demonstrated the folly of central bank overreaction -- or, rather, submission to market whims. That is why the Fed has looked more steadfast this year, with all signs pointing toward a 25 basis-point rate hike in June. At the least, expect the Fed to again acknowledge a tighter labor market and progress toward its inflation goals despite the surprising dip in the CPI recently.

The bond market spent last week in consolidation mode, absorbing heavy supply brought on by the Treasury Department's auctions of $88 billion in two-, five-and seven-year notes, as all-important 10-year yields sit right on top of a key support level in the area of 2.32 percent. That area has been the battlefield for those who watch the bond charts closely, as any move of even a couple of basis points either way will bring in momentum traders, accelerating the next move.

That is why this week's economic data is so crucial to the market. Traders have already reacted to the French elections, and no further surprises are anticipated there as centrist candidate Emmanuel Macron has a solid lead over euroskeptic Marine Le Pen. The fireworks over the Trump administration's tax plan will die down since we are not likely to get much clarity on the topic for quite some time while Congress and the White House try to put some flesh on the bare-bones proposal that was revealed last week. Despite President Donald Trump's tweets regarding the elevated possibility of conflict with North Korea, the market is coming to the realization that the U.S. remains dependent on the Chinese to influence the North, as any kind of attack would lead to unthinkable casualties in South Korea and possibly Japan.

While the balance of risks in the Treasury market do not appear to favor either the bull or bear camp at this juncture, if Fed policy makers repeat the timeline set before the March FOMC meeting, as I would expect, then they will be more aggressive in guiding the Treasury market toward a higher probability of a June hike by the end of this month. The hedge funds and other big speculators, having been burned badly in April, will be more circumspect in their approach this time. Those chart watchers could be frustrated for quite some time, as the Treasury market hovers right on their key trigger levels. False breakout signals often lead to over-trading, and death by a thousand cuts.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Scott Dorf is a managing director at Amherst Pierpont Securities. He has been selling and trading U.S. Treasuries for more than 30 years.

To contact the author of this story: Scott Dorf at sdorf7@bloomberg.net.

To contact the editor responsible for this story: Robert Burgess at bburgess@bloomberg.net.

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