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Bond Traders Look to Jobs for Taper Clues While Cash Glut Grows

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The glut of spare cash in dollar funding markets is combining with inflation concerns to stoke debate among investors about just how soon the Federal Reserve might have to take its foot off the accelerator.

Bond traders are keenly attuned to the buildup of dollars in short-term interest-rate markets, an overabundance reflected in the amount of money sitting and earning absolutely nothing at the Fed’s reverse repo facility.

For some, that’s yet another sign that the so-called quantitative easing program ought to be dialed back from its current pace of $120 billion a month, although others say that the central bank facility is acting like it should, as a safety valve, and also point to the other factors fueling the oversupply.

Either way, the cash pile — and whether the usage of the Fed’s facility resumes its upward trajectory after slipping on Friday — is set to be a key focus for traders in the coming week along with crucial U.S. jobs data, which may give clues about just how strong growth and inflation really are.

“Progress toward achieving the dual mandate should be the biggest factor” driving decisions about policy tightening, said Credit Suisse Group AG strategist Jonathan Cohn, referring to the Fed’s twin goals on employment and consumer prices.

The drumbeat of policy makers making noises about when the Fed should debate tempering its asset purchases has been quickening, although officials have been careful to say that their views are premised on the economy continuing to power forward and the prospects for sustained inflation.

The strength of the upcoming labor market report is therefore set to be a major catalyst for bets about when both tapering and rate hikes might begin to take place, as will the evolution of funding markets.

The next central bank policy meeting will take place June 15-16, while there is talk of possible tapering signals coming out of the Kansas City Fed’s annual gathering at Jackson Hole in August.

Money-market traders are currently pricing in about 18 basis points worth of Fed rate hikes by the end of next year — down around 3 basis points from levels late last month. That equates to around a 72% chance of a standard 25 basis-point increase in 2022.

Before they even get to that point though, officials need to get through tapering, and most analysts expect there to be a lag before they embark on pushing interest rates higher.

Asymmetric Risk

The yield on 10-year notes has drifted slightly lower over the past couple of weeks, although it received some support in recent days from reports about government budget proposals and at around 1.59% is firmly entrenched in the range that it’s been in for a few months.

Bond-market inflation expectations, as measured by so-called breakeven rates, have also eased back slightly, although they remain within sight of the decade highs they reached earlier in May.

Some traders are wary that the upcoming report on May job creation could reignite the move higher in long-term yields.

The median forecast of economists surveyed by Bloomberg is for an increase in payrolls of around 671,000 people and a figure of that magnitude or higher could make the prior month’s unexpectedly weak reading seem like a one off. There is also the prospect of a revision to figures for April, which came in at around 266,000 despite earlier predictions for a gain of 1,000,000.

“The risks in the market are asymmetric toward higher yields,” said John Briggs, global head of desk strategy at Natwest Markets. “After last month’s payroll figure, economists are being conservative this time, so there’s a chance the actual figure is above consensus. And after that, people will then start to worry about the next consumer price report,” set to be released on June 10.

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