Lowering of Federal Reserve Interest Rates May Not Guarantee a Decrease in Bond Yields

In a recent speech, Federal Reserve Chair Jerome Powell did not significantly alter market expectations for a September rate cut, as these were already factored into Fed Fund futures. However, the speech did not deviate significantly from previous statements, with Powell acknowledging that the BLS job data was not as strong as initially believed.

The data continues to suggest that inflation is unlikely to improve anytime soon. This is evidenced by the Philadelphia Fed's price paid index, which rose to its highest level since July 2022, potentially leading to an increase in inflation pricing if reflected in upcoming CPI or PPI reports.

The bond markets may respond to Powell and the Fed's policies with rising rates, particularly at the back of the curve, due to inflation fears. The structure of the yield curve, as suggested by Powell's speech, is expected to come in the form of a bear steepener.

Meanwhile, the bond markets might prove less forgiving than expected, given the risk of inflation. One-year CPI inflation swaps rose on the day following Powell's speech, remaining anchored at the upper end of the trading range from the past three years.

Elsewhere, the spread between Italian and German 10-year rates is at its tightest since before the 2008 financial crisis. In the United States, the 30-year rate is currently at a high point and may continue to rise. The technical view of one-year and five-year CPI swaps charts suggests that inflation expectations will continue to rise.

Interestingly, rate cuts from the Fed do not necessarily cause long-term rates (10 and 30-year) to fall in kind. This is a challenge faced by Powell and the Fed, as they have limited options to control long-term rates outside of quantitative easing or yield curve control.

The Bank of England, on the other hand, has been cutting rates regularly, but this hasn't affected the 30-year rate significantly. If the market prioritizes inflation concerns over potential unemployment impacts, it will demand higher rates.

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Finally, if the August job report is a disaster, Powell left the door open for a rate cut in September. However, it's important to note that the Fed can adjust its stance on monetary policy independently of the market.

In conclusion, the current economic landscape is characterized by rising inflation expectations and a possible response from the bond markets. As always, it's crucial for investors to stay informed and adapt their strategies accordingly.