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No escape from biggest bond losses in decades as Fed continues to hike

(Bloomberg) – Investors who may be looking for the world’s largest bond market to bounce back from its worst losses in decades look set to be disappointed.

Friday’s US jobs report illustrated the economic dynamics in the face of an escalating Federal Reserve cooling effort, with businesses quickly adding jobs, wages rising. and more Americans entering the workforce. While Treasury yields fell on data showing mild wage pressures and rising unemployment, the overall picture reinforces speculation that the Fed is poised to keep raising rates — and keep them at that – until inflation falls.

Swap traders are pricing in an even slightly better chance that the central bank will continue to raise the benchmark rate to 3/4 of a percentage point on September 21 and tighten policy until when reaching about 3.8%. That suggests more downside potential as 10-year Treasury yields have been above or equal to the Fed’s peak yield in previous monetary tightening cycles. That yield is now about 3.19%.

Kerrie Debbs, a certified financial planner at Main Street Financial Solutions, said inflation and the Fed’s hawkish attitude had “bitten the market”. “And inflation won’t go away for a few months. This fact stings. “

According to the Bloomberg index, the Treasury market has lost more than 10% in 2022, sending it into its deepest annual loss and first consecutive annual decline since at least the early 1970s. , according to a Bloomberg index. The recovery that began in mid-June, fueled by a recession that will lead to a rate cut next year, has largely been scrapped as Fed Chairman Jerome Powell emphasized that he is focused on getting the job done. entirely on reducing inflation. The yield on the two-year Treasury note on Thursday hit 3.55%, the highest since 2007.

At the same time, short-term real yields – or yields adjusted for inflation expectations – have increased, signaling a significant tightening of financial conditions.

Rick Rieder, chief investment officer for global fixed income at BlackRock Inc., the world’s largest asset manager, is among those who think long-term yields could rise further. He said in an interview on Bloomberg TV on Friday that he expected the Fed’s policy rate to rise 75 basis points this month, which would be the third move in a row of that size.

According to Rieder, Friday’s labor report showed a slowdown in wage growth allowing the market to “breathe a sigh of relief”. He said his company has purchased some short-term fixed-income securities to capture as yields rise, but he thinks longer-maturity bonds have room to rise.

“I can see rates going higher in the long run,” he said. “I think we are in a range. I think we’re at the top of the range. But I think it’s hard to say we’ve seen the current high. “

The jobs report is the last major look at the job market ahead of this month’s meeting of the Federal Open Market Committee.

The upcoming shortened week has a number of economic reports coming out, including a survey of purchasing managers, the Fed’s Beige Book on regional conditions, and weekly unemployment benefits. US markets will be closed on Monday for the Labor Day holiday and the most important indicator ahead of the Fed meeting will be the release of the consumer price index on September 13.

But markets will be analyzing comments closely from a range of Fed officials who will speak publicly next week, including Cleveland Fed President Loretta Mester. She said on Wednesday that policymakers should push lending rates to more than 4% early next year and indicated she does not expect a rate cut in 2023.

Greg Wilensky, head of US fixed income at Janus Henderson, said he is also focused on the upcoming release of wages data from the Atlanta Fed ahead of the next policy-setting meeting. On Friday, the Labor Department reported that average hourly earnings rose 5.2 percent in August from a year earlier. This is slightly below the 5.3% expected by economists, but it still shows upward pressure on wages due to the tightening labor market.

“I am in the 4% to 4.25% range on the final rate,” Wilensky said. “People are realizing that the Fed won’t pause on softer economic data unless inflation weakens significantly.”

The specter of an aggressive Fed tightening has also affected equities, sending the S&P 500 index down more than 17% this year. While US stocks rallied from their June lows through mid-August, they have returned most of that gain on bets on an impending recession and a 2023 rate cut that has yet to be announced. perform.

“You need to be humble about your ability to forecast your data and how rates will react,” said Wilensky, who has Treasury core bond funds. “The worst is over as the market is doing a more sensible pricing job where rates should be. But the big question is what’s going on with inflation? “

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