Traders Who Brushed Off Powell’s Words Face Tests From Hard Data

(Bloomberg) — Traders who’ve shrugged off Federal Reserve Chair Jerome Powell’s repeated warnings that interest rates will remain elevated this year will have their wagers tested again within weeks by key economic data.

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“There’s going to be a lot for the market to absorb in terms of challenges,” said John Vail, chief global market strategist for Nikko Asset Management in Tokyo.

He expects January inflation and retail sales figures in the US due in the middle of the month to come in strong, increasing the likelihood that the bond market will have to rapidly reprice the chance of a dovish pivot from the Fed.

Treasury yields dropped about 10 basis points in the 2-10 year maturity zone on Wednesday. The moves held through the Asian trading day Thursday and left the 10-year yield around 3.4%, from as high as 3.8% at the start of the year.

“Inflation numbers could be very high in January and February. They may reach 0.4% or 0.5% month-over-month at least unless something unusual happens,” said Vail. “Retail sales in January will surge, in nominal terms, because auto sales came out very strong.”

Market pricing implies nearly 50 basis points of rate cuts this year from the Fed, in stark contrast to Powell’s stance.

“The market has gotten ahead of itself,” said James Sarni, managing principal for Payden & Rygel. “The disconnect between what the market believes and what the Fed will do is among the biggest risks in the fixed income market.”

Sarni anticipates the eventual capitulation of the bond market could push benchmark 10-year Treasury yields to 4% or higher before the end of the year.

“The bigger unknown is whether it would be sustained,” he said. If inflation doesn’t come down and only levels off, it’s likely we would see that sort of level sustained.”