Key Highlights

• May FOMC will offer little more than “wait and see”
• Inflation expectations at long horizons remain anchored
• US Treasurys have lost their safe-haven status since the election

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FOMC expectations unmoved

EXHIBIT #1:  IMPLIED FEDERAL FUNDS RATE

_{Source: BNY Markets, Bloomberg}

Wednesday’s upcoming FOMC meeting will offer few fireworks. No rate move is expected, and without a Summary of Economic Projections the only additional information we’ll receive beyond the meeting’s prepared statement will be Chair Powell’s press conference. Given the consistency of his message, including at his last appearance just before Easter, we don’t expect any departures from those themes in his remarks on Wednesday.

Central to that message is the assertion that the tariff policies as announced would have large effects on prices and economic production, but it’s too early – and still too uncertain – to be prescriptive on rate policy. Furthermore, given the impact that the announced tariff regime would have on prices, it’s crucial to ensure that inflation expectations remain well anchored.

This last bit points to a longer hold, and given the resilience of hard data lately, including a better-than-expected jobs report, we don’t expect the data to weaken to a point that would justify a Fed cut until July. Therefore, we foresee a May pause (as almost everyone does), as well as one for the June 18 meeting. Market pricing agrees with this assessment, with the odds of a cut in June at just 27%, while for July 30 there is 64% probability of a cut priced in as of today. Market pricing for the rest of the year, which whipped around during April’s extreme market volatility, is today virtually unchanged from the day after the last Fed meeting, as Exhibit #1 shows. All in all, not a momentous meeting, given that the Fed is as perplexed by the uncertainty as markets in general.

As for inflation expectations, while it is true that short-term expectations have increased significantly, longer-term expectations are still well behaved. Exhibit #2 shows the term structure of breakeven expectations derived from TIPS pricing. Note the inverted nature of this curve. If this remains the case by the end of July and the real economic data have indeed weakened as we expect, it will open the door for the next rate cut – especially if oil prices remain under pressure as they are currently.

Going forward, we maintain our view that as long as the tariff regime as announced remains the same, the economy will indeed soften. April payrolls beat expectations at 117k new jobs, well in excess of the 13k consensus expectation. The survey period was the week following “Liberation Day,” so it’s likely that any labor market reaction to the announcement was not picked up, meaning we’ll have to wait a month or two for confirmation of a slowdown. Our view is that by the time the June data are published in early July, the jobs outlook will start to deteriorate clearly, allowing the Fed to cut rates at the end of that month. 

Long-term inflation expectations are well-anchored

As a result of binding the debt ceiling earlier in the year, Treasury has cut T-bill issuance significantly. Net issuance by Treasury has fallen by over $21bn since the end of 2024. Once the debt ceiling is addressed, we expect a quick rebound in short-term debt offered to the public. For comparison, in 2023, during the last debt ceiling episode between February and the end of May, net bills were cut by over $100bn. After the debt ceiling was finally suspended in early June, Treasury fully reversed the decline in T-bill supply by early September, issuing an almost identical $100bn over the three-month period.

There should be no shortage of buyer of new bills. Our iFlow data suggest demand by investors is inelastic to changes in supply. Exhibit #2 shows the rolling 20-day (i.e., approximately one month) sum of net bill supply against the rolling 20-day average of flows into the very front end of the curve (0–1y). Real money responds to fluctuations in T-bill issuance quite quickly. 

EXHIBIT #2: BREAKEVEN INFLATION 1Y TO 10Y

_{Source: BNY Markets, Bloomberg}

Safe-haven status of Treasurys wanes

We have written a great deal about the selling of U.S. Treasurys by cross-border investors and have noted that with the decline in market volatility in recent weeks, this phenomenon has eased up (see here) – although still within the context of broadly weaker foreign demand for U.S. sovereign debt. Instead, our iFlow data show that selling Treasurys and buying European sovereign debt is the current trade.

In addition to broadly weaker foreign demand for USTs, it’s notable to point out that in the last few months of 2024 and the beginning of this year so far, USTs are not behaving as a safe-haven asset, contrary to traditional thinking. This can be seen in Exhibit #3, where we show how 10y UST yields moved with changes in the VIX, a straightforward measure of market volatility. The top panel covers the period from the beginning of 2023 through the U.S. presidential election. The relationship between yields and equity vol appears nonexistent. A (polynomial) regression line shows there is barely any directional relationship.

However, the lower panel shows the same data since November 5, and as we can see in the highlighted area, when VIX rises so do 10y yields. The regression line clearly shows the relationship is positive – higher market volatility resulted in higher bond yields, contrary to what one would expect if USTs did indeed display safe-haven properties.

It’s too early to say if this relationship will continue or if USTs will regain their attractiveness in times of stress but suffice it to say that in recent months this hasn’t been the case. It’s possible that a return to a more normal market pattern will see a reassertion of the safe-have properties of USTs, but in the context of generally weaker foreign demand, we may not see it reverse.

EXHIBIT #3: U.S. TREASURYS AND VIX

_{Source: Source: BNY Markets, Bloomberg}

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