NEW YORK, Aug 25 (Reuters) – Federal Reserve Chair Jerome Powell did little on Friday to steer markets away from the “longer-term higher” interest rate mantra that has been pushing Treasury yields higher in recent weeks has driven some investors to look for more cautious bets if the economy cannot avoid a downturn next year.
Speaking at the Kansas City Fed’s annual meeting in Jackson Hole, Wyoming, Powell left open the possibility of further rate hikes and stressed the surprising strength of the US economy, although he acknowledged a slowdown in the pace of inflation over the past year.
While the speech was more balanced than the Fed Chair’s extremely hawkish speech at last year’s Jackson Hole symposium, it still offered little comfort to those hoping the central bank would agree to eventual rate cuts in 2024.
For some investors, that sentiment also heightened concerns about the risk that higher yields could eventually weigh on robust economic growth and trigger a potential downturn, though most believe the US is likely to avoid a recession in 2023.
“The risk of a recession is in 2024, so we want to … make sure we have corporate debt that’s well positioned to weather a downturn,” said Cindy Beaulieu, chief executive and portfolio manager at Conning, which has $205 billion under management .
“Those types of deals are important right now, rather than trying to take on additional credit risk,” she said.
Financial markets on Friday saw little of the volatility associated with last year’s Jackson Hole controversy, as stocks fell more than 3.4%.
Benchmark 10-year government bond yields, which move counter to bond prices, were flat on the day at around 4.239%, but remained close to the 16-year highs set earlier in the month. Two-year yields – which are more closely linked to monetary policy expectations – gained about three basis points.
Stocks, which faltered in August as rising bond yields threatened to dampen the appeal of equities, were little changed, with the S&P 500 up 0.22%. Options markets had priced in an index move of around 0.9% ahead of the session.
The rise in bond yields in recent months – driven by bets that the Fed will have to hold rates at current levels longer than expected to prevent a resurgence of inflation – has impacted the economy and 30-year mortgage rates The highest level in over 20 years, while credit spreads, a measure of risk, widened slightly this month.
Investors said a lot depends on what data reveals over the next few weeks. The US will release August jobs data on September 1st and consumer price data on September 13th.
“Powell appears to be buying time and waiting for more data to come in so they can prepare to continue on the soft landing trajectory,” said Anders Persson, chief investment officer, global fixed income, at Nuveen.
RECESSION CONCERNS RESUME
Some investors feared that higher rates could weigh on growth and increase the likelihood of a recession next year. Such a scenario would theoretically force the Fed to cut rates, causing bond yields to fall.
“The prospect of a soft landing is slimmer after today,” said Mike Sewell, a portfolio manager at T. Rowe Price, which expects an increase in long-dated bonds during the fourth quarter as the US economy begins to weaken.
“We’re waiting for financial conditions to collapse,” he said.
Fed fund futures traders have priced in rate cuts totaling nearly 100 basis points for the coming year, about the same as speculation pre-Powell’s speech, but the first rate cut has been pushed back to June from May.
Certainly, betting against the US economy has been a risky proposition this year. Many banks have pared back calls for a 2023 recession in recent months, while bets on economic resilience have helped the S&P 500 rally 15% year-to-date.
At the same time, many investors seem convinced that yields will remain high for the time being.
Hedge funds’ bearish bets on long-dated US Treasuries have been building for several weeks, with net short positions in 10-year Treasury futures at their highest levels since early July, according to data from the Commodity Futures Trading Commission last week reached.
“The market is very tight,” said Josh Emanuel, chief investment officer at investment management firm Wilshire.
Despite the risk that long-term bond yields could rise, he wanted to increase the duration of his portfolio. “Technically neutral today but becoming increasingly bullish on long-dated government bonds.”
Reporting by Davide Barbuscia and David Randall; Edited by Ira Iosebashvili and Andrea Ricci
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