One Word Grips the Bond Market Before Crucial Inflation Update

(Bloomberg) -- Bond traders will have one word on their minds as they gear up for the latest readings on inflation: “transitory.”

That's how Federal Reserve Chairman Jerome Powell characterized the factors behind muted price pressures after last week's policy meeting, where officials kept interest rates unchanged. Markets whipsawed on his comments, with benchmark 10-year Treasury yields bouncing off their lowest levels in a month.

This week, traders get to see if Powell's right, with updates on producer and consumer price indexes. Friday's CPI report is expected to show that inflation picked up last month. Still, the bar will be high when it comes to altering market expectations for the Fed's path, according to TD Securities. Powell said officials don't “see a strong case” for moving rates in either direction, and futures traders seem to agree: They still expect a quarter-point cut as the next move, but it's not fully priced in until mid-2020.

“CPI will be quite crucial, as Chair Powell hinted at some of the transitory factors weighing down inflation,” said Gennadiy Goldberg, a senior U.S. rates strategist. “A stronger inflation report could help push back on some of the pricing for rate cuts this year, though I think some doubts will remain since this will be viewed as only one reading.”

That skepticism was evident Friday. Despite a robust U.S. labor report, traders barely changed expectations for when a cut would be fully priced in, as they zeroed in on tame earnings growth. Yields on 10-year Treasuries ended the week at 2.53 percent, after swinging in a 12-basis-point weekly range -- the largest span in over a month.

Entrenched View

Schroder Investment Management's Lisa Hornby is of a similar mind when it comes to the resilience of rate-cut wagers. Though inflation is “the most important data we have to look at,” the portfolio manager says it will take more than one report to sway the market.

“It will take a lot to move the Fed and therefore, market pricing,” Hornby said. “The Fed is firmly on hold until a direction comes clear” as far as the trajectory of inflation.

She anticipates range-bound trading, but sees scope for higher yields. She says she'd buy should 10-year yields exceed 2.7 percent in the next few weeks -- a level last seen in March.

Consumer prices, excluding food and energy, probably rose 0.2 percent in April from the prior month, and 2.1 percent on a yearly basis, a slightly quicker pace than seen in March, according to the median forecasts in a Bloomberg survey. Any surprise to the upside could douse yield-curve steepening bets, according to Goldberg.

“A firmer inflation print will help yields rebound somewhat, but that rebound may be concentrated in the front-end of the curve, which could lead the curve to flatten further,” he said.

Goldberg said he'll also monitor this week's barrage of Fed speakers for any push-back on the view Powell laid out last week. More than a half-dozen policy makers are scheduled to appear this week, including the chairman.

What to Watch

Along with PPI, CPI, Fedspeak and auctions, traders are also going to watch the next round of U.S.-China trade talks, which are scheduled to start in Washington this week
Here's the economic calendar:
- May 7: JOLTS job openings; consumer credit
- May 8: MBA mortgage applications
- May 9: Producer price index; trade balance; jobless claims; Bloomberg consumer comfort; wholesale trade sales/inventories
- May 10: CPI; real average earnings; monthly budget statement
Fedspeak continues apace:
- May 6: Philadelphia Fed's Patrick Harker
- May 7: Dallas Fed's Robert Kaplan in Beijing; Vice Chairman Randal Quarles
- May 8: Governor Lael Brainard
- May 9: Powell gives opening remarks at community development conference, where Chicago Fed's Charles Evans will also speak; Atlanta Fed's Raphael Bostic
- May 10: Brainard; Bostic; New York Fed's John Williams
- Auctions ahead:
  - May 6: $39 billion of 3-month bills; $36 billion 6-month bills
  - May 7: $38 billion 3-year notes
  - May 8: $27 billion 10-year notes
  - May 9: 4-, 8-week bills; $19 billion 30-year bonds