Powell Juices Bond Market Bet on Inflation With Tilt to Jobs

Federal Reserve Chair Jerome Powell’s increasing focus on protecting the job market is encouraging a swath of bond traders putting bets on inflation rates to remain elevated.

“Powell essentially endorsed being long breakevens,” said Tim Magnusson at Garda Capital Partners, referring to a trading strategy that profits from inflation-linked securities outperforming regular Treasuries.

The Fed chief for the first time in the current cycle last week in his press briefing rammed home the point that a surprise increase in unemployment could prompt officials to lower interest rates. Central bank policymakers’ updated forecasts, released March 20, also featured a faster expected pace of inflation and growth for 2024 while retaining a projection for three rate cuts in the so-called dot-plot.

“I guess they are willing to tolerate a little more inflation than what we otherwise would have thought,” said Magnusson, the hedge fund’s chief investment officer.

inflation expectations climbed this year

Magnusson’s not alone in his take. Bank of America Corp. strategists, led by Mark Cabana, on Wednesday recommended bets on 30-year breakevens. “A Fed that is guiding to cut alongside easy financial conditions, stronger growth expectations and greater upside risk to inflation suggests higher inflation compensation.”

The breakeven market suggests that inflation expectations have been creeping higher. The five-year breakeven rate — which measures the difference between the yield on regular five-year notes versus their inflation-protected counterparts — is currently about 2.43% — well below the peak of around 3.76% in early 2022 - yet roughly 40 basis points up from the December low.