Bond traders glimpse taper-talk roadmap that revives volatility

New York

BOND investors are confident that the calm engulfing the Treasury market for months will have a limited shelf life.

A report on May job growth that disappointed some traders did spark a burst of short-covering on Friday. But it left intact speculation that the US recovery from the pandemic is strong enough to lead the Federal Reserve to finally start discussions this month around the idea of tapering its massive bond-buying programme.

No policy move is expected at the June 15-16 Fed gathering. The options market is coalescing around an actual shift - with the potential to bust yields out of their volatility-killing range trade - in August. That's when the Fed traditionally holds its annual meeting in Jackson Hole, Wyoming, which has served as a venue in the past for important policy signals.

"The Fed at least will acknowledge that they have moved out of the not-even-talking-about-talking-about-tapering to talking about it" this month, said Gene Tannuzzo, a portfolio manager at Columbia Threadneedle.

"Our timeline for an announcement would centre on Jackson Hole as a forum to float an academic discussion on the topic" and September as the base case for unveiling a plan to reduce bond buying, setting the 10-year yield up for a likely climb to 2 per cent by year-end, he said.

Tapering looms large for financial markets because the Fed has signalled that it will be a precursor to actual rate increases. While policy makers project that they'll keep overnight rates near zero at least through 2023, bond traders have been betting for months that liftoff will come early that year.

With investors holding firm on those expectations for now, volatility has been slumping. A measure of future price swings in Treasuries is around the lowest since February. And 10-year yields have traded sideways, pivoting around 1.6 per cent for weeks, after reaching a more than one-year high of 1.77 per cent in March.

The lead-up to the Fed's June 16 decision isn't devoid of risk. Next week brings a report that's forecast to show consumer prices accelerated in May at the fastest pace since 2008. That's after April's above-forecast reading pushed yields towards the upper end of their recent range. There's also a US$120 billion round of note and bond auctions to absorb next week.

Jeffrey Rosenberg, a senior portfolio manager at BlackRock, also saw May's job report - which included robust wage growth - as leaving the Fed on course to send some signalling in June of a slow movement towards eventually reducing asset purchases.

The Fed is currently buying around US$120 billion in debt each month - US$80 billion of Treasuries and US$40 billion of mortgage-backed securities. The central bank has said it will continue to do so until it has made "substantial further progress" towards its employment and price goals.

"Until the Fed talks about tapering, or if we get an ugly inflation number, the current yield levels will hold for the time being," said Gary Pollack, head of fixed-income for private wealth management at Deutsche Bank. "But I expect that yields will be higher by the end of the year, with 10-year yields moving to 2 per cent." BLOOMBERG