A Warsh-Led Fed Stands to Reignite the Treasuries Steepener BetAI Quick Read(Bloomberg) -- Wall Street strategists say that a Kevin Warsh-led Federal Reserve may jolt the $31 trillion Treasuries market out of its narrow trading ranges, urging investors to position for shorter-dated yields to eventually move lower.
US yields rose two to three basis points on Monday, staying on pace for their tightest monthly range since late 2020. With talks between the US and Iran to end the war at an impasse and the Federal Reserve widely expected to keep interest rates steady this week, the 10-year yield was up three basis points to 4.33%.
That low-volatility environment — at least in cash bond trading — has strategists looking ahead to longer-term catalysts as Warsh, a former Fed governor, faces a vote this week to succeed Jerome Powell as the central bank’s chair.
To Morgan Stanley strategists led by Matthew Hornbach, a Warsh-led Fed stands to target new inflation metrics, provide markets with less forward guidance, and push for a smaller balance sheet — which “may lift meeting-to-meeting volatility.” They, and others on Wall Street, expect a boost to shorter-dated yields and a revival of the so-called curve steepener trade.
For now, though, the bond market is holding roughly steady after slumping last month. Elevated oil prices have been seen posing a risk to inflation that, if sustained, could ultimately hurt growth and slow the economy. Money managers will monitor Powell’s comments at this week’s meeting for any clues on how the central bank is assessing the economic impact of the war.
Traders are leaning toward a reduction by the end of the year, pricing in eight basis points of a quarter-point cut by the December meeting. Rate reductions are often seen bringing down front-end yields and helping steepen the gap out to longer-term, 10- and 30-year maturities.
Fed officials “are going to try and buy time as they are seeing a pretty strong economy, above-target inflation,” said Robert Tipp, head of global bonds and chief investment strategist at PGIM Fixed Income. “They’re going to want to avoid shocking the markets and creating an inadvertent tightening of financial conditions.”
For now, he sees shorter-maturity Treasuries at risk depending the read-through from the conflict into economic data. Investors will watch a reading of the Fed’s preferred gauge of inflation on Thursday.
Already this week, the slightly weaker tone in the market helped entice bidders for sales of $69 billion of two-year notes and $70 billion of five-year notes. A $44 billion auction of seven-year notes is due on Tuesday.
“We have a rare combination of Iran-US headline drivers, economic data and major earnings releases this week, any of which can shake things up,” said Jack McIntyre, portfolio manager at Brandywine Global Investment Management. “The bar is high for the Fed to jawbone market expectations one way or the other.”
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