Bond traders look to job figures for taper clues as cash glut grows

Washington, DC

THE glut of spare cash in US dollar funding markets is combining with inflation concerns to stoke debate among investors about just how soon the US Federal Reserve might have to take its foot off the accelerator.

Bond traders are keenly attuned to the buildup of US dollars in short-term interest-rate markets, an overabundance reflected in the amount of money sitting and earning absolutely nothing at the Fed's reverse repo facility.

For some, that is yet another sign that the so-called quantitative easing programme ought to be dialled back from its current pace of US$120 billion a month, although others say that the central bank facility is acting like it should, as a safety valve, and also point to the other factors fuelling the oversupply.

Either way, the cash pile - and whether the usage of the Fed's facility resumes its upward trajectory after slipping on Friday - is set to be a key focus for traders in the coming week along with crucial US jobs data, which may give clues about just how strong growth and inflation really are.

"Progress towards achieving the dual mandate should be the biggest factor" driving decisions about policy tightening, said Credit Suisse Group strategist Jonathan Cohn, referring to the Fed's twin goals on employment and consumer prices.

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The drumbeat of policymakers making noises about when the Fed should debate tempering its asset purchases has been quickening, although officials have been careful to say that their views are premised on the economy continuing to power forward and the prospects for sustained inflation.

The strength of the upcoming labour market report is therefore set to be a major catalyst for bets about when both tapering and rate hikes might begin to take place, as will the evolution of funding markets.

The next central bank policy meeting will take place June 15-16, while there is talk of possible tapering signals coming out of the Kansas City Fed's annual gathering at Jackson Hole in August.

Money-market traders are currently pricing in about 18 basis points worth of Fed rate hikes by the end of next year - down around three basis points from levels late last month. That equates to around a 72 per cent chance of a standard 25 basis-point increase in 2022.

Before they even get to that point though, officials need to get through tapering, and most analysts expect there to be a lag before they embark on pushing interest rates higher

The yield on 10-year notes has drifted slightly lower over the past couple of weeks, although it received some support in recent days from reports about government budget proposals and at around 1.59 per cent is firmly entrenched in the range that it has been in for a few months.

Bond-market inflation expectations, as measured by so-called breakeven rates, have also eased back slightly, although they remain within sight of the decade highs they reached earlier in May.

Some traders are wary that the upcoming report on May job creation could reignite the move higher in long-term yields.

The median forecast of economists surveyed by Bloomberg is for an increase in payrolls of around 671,000 people and a figure of that magnitude or higher could make the prior month's unexpectedly weak reading seem like a one off.

There is also the prospect of a revision to figures for April, which came in at around 266,000 despite earlier predictions for a gain of 1,000,000.

"The risks in the market are asymmetric toward higher yields," said John Briggs, global head of desk strategy at Natwest Markets.

"After last month's payroll figure, economists are being conservative this time, so there's a chance the actual figure is above consensus." BLOOMBERG