What everyone now can assume
Is Jay and his friends in the room
Will never raise rates
Thus, tempting the fates
In search of a ne’er ending boom
Well, that’s that! To anyone who thought that the Fed was concerned over rising back-end yields and a steeper yield curve, Chairman Powell made it abundantly clear that it is not even on their radar. No longer will the Fed be concerned with mere forecasts of economic strength or pending inflation. As in the Battle of Bunker Hill, they will not “…fire until they see the whites of [inflation’s] eyes”. “Until we give a signal, you can assume we are not there yet,” Powell explained when asked about the timing of tapering asset purchases and tightening policy. It would seem that is a pretty clear statement of intent on the Fed’s part, to maintain the current policy for years to come.
To recap, the Fed raised their forecasts for GDP growth to 6.5% in 2021, 3.3% in 2022 and 2.2% in 2023, while increasing their inflation forecasts (core PCE) to 2.2%, 2.0% and 2.1% respectively for the same years. Finally, their view on unemployment adjusted to 4.5% this year with declines to 3.9% and 3.5% in ’22 and ’23. All in all, they have quite a rosy view of the future, above trend growth, full employment and no inflation. I sure hope they are correct, but I fear that the world may not turn out as they currently see it through their rose-tinted glasses. The market’s biggest concern continues to be inflation, which, after decades of secular decline, appears to be at an inflection point for the future. This can be seen in the bond market’s reaction to yesterday’s activities.
Prior to the FOMC statement, (which, by the way, was virtually verbatim with the January statement, except for one sentence describing the economic situation), risk was under pressure as equity markets were slipping, 10-year Treasury yields were rallying to new highs for the move and the dollar was firming up. But the statement release halted those movements, and once the press conference got underway, Powell’s dovishness was evident. This encouraged all three markets to reverse early moves and stocks closed higher, bonds flat and the dollar softer. It seems, there was a great deal of positive sentiment at that time.
However, over the ensuing 16 hours, there has been a slight shift in sentiment as evidenced by the fact that the 10-year Treasury is now down 2/3’s of a point with the yield higher by 8 basis points, rising to 1.72%. This is the highest yield seen since January 2020, pre-pandemic, but certainly shows no sign of stopping here. In fact, 30-year Treasuries now yield 2.5%, their highest level since July 2019, and here, too, there is no evidence that the move is slowing down. If anything, both of these bonds appear to be picking up speed in their race to higher levels. Meanwhile, TIP yields are climbing as well, but not quite as quickly taking the 10-year breakeven to 2.31%. In other words, that is the market forecast for inflation. FYI, this is the highest level in this measure since May 2013. As mentioned above, it appears there is a secular change in inflation on the way.
Perhaps what makes this most remarkable is the dramatic difference in the Fed’s stance and that of some other major central banks. On the one hand, Madame Lagarde informed us last week that the ECB would be speeding up their PEPP purchases to counter the effect of rising yields. Again, this morning she explained, “what we are responding to is a yield increase that could get ahead of the expected economic recovery.” On the other hand, the Norges Bank, while leaving rates on hold at 0.00% this morning predicted it would start raising rates in the “latter half” of this year, far sooner than previous expectations. Meanwhile, in the emerging markets, we have an even more aggressive story, with the Banco Central do Brazil raising the overnight SELIC rate by a more than expected 0.75% last night, as despite Covid continuing to ravage the country and the economy stuttering, inflation is starting to move higher at a faster pace.
The point here is that after almost a full year of synchronous monetary policy around the world, things are starting to change at different rates in different places. The one thing almost certain to follow from this change in policies is that market volatility, across all asset classes, is likely to increase. And since most markets either get measured in dollars, or versus dollars, and the inherent volatility in the US bond market is increasing, we may soon be testing central bank limits of control, especially the Fed’s. After all, if the 2yr-10-yr spread widened to 2.75%, a level it has reached numerous times in the past, will the Fed remain sanguine on the subject? Will the stock market implode? Will the dollar race higher? These are the questions that are likely to be on our lips going forward. The fun is just beginning as the Fed embarks on its new policy roadway.
With all that in mind, what is this morning’s session doing? Based on the different central bank activities, things are performing as one would expect. The initial warm glow following the FOMC meeting followed into Asia with gains in most major markets there (Nikkei +1.0%, Hang Seng +1.3%, Shanghai +0.5%) although Australia’s ASX 200 fell 0.7% during the session. Meanwhile, Lagarde’s comments, reiterating that the ECB would be buying more bonds has encouraged equity investors in Europe with gains across the board led by the DAX (+1.2%), although the rest of the set are far less impressive (CAC +0.25%, FTSE 100 +0.1%). However, US futures tell a different story, as the rising long bond yields are continuing to have a severe impact on the NASDAQ with futures there -1.0% and dragging SPX (-0.3%) down with it although DOW futures have actually edged higher by 0.2%. This is the ongoing rotation story, out of growth/big tech and into value and cyclical stocks.
In the bond market, the damage is severe with Treasuries leading the way followed by Gilts (+5.5bps) as the market awaits the BOE meeting results, and then much smaller rises in yields on the continent (Bunds +2.6bps, OATs +1.9bps, Italian BTPs +1.7bps) as traders recognize that the ECB is going to prevent a dramatic decline there.
Perhaps the most surprising outcome this morning is in the commodity bloc, where virtually all commodity prices are lower, albeit not by too much. Oil (-0.3%), gold (-0.5%) and copper (-0.3%) are uniformly under pressure. This could be a response to the Fed’s benign inflation forecasts, but I think it is more likely a response to the dollar’s strength.
Speaking of the dollar, it is mostly stronger this morning, recouping the bulk of yesterday afternoon’s losses. In the G10, only AUD (+0.25%) is higher of note after the employment report released overnight showed far more strength than expected (Unemployment Rate fell to 5.8%). But otherwise, the rest of the bloc is under pressure, once again led by SEK (-0.45%) and CHF (-0.35%), with both currencies seeing outflows on the back of higher USD yields. In the EMG bloc, TRY (+2.0%) has just jumped higher after the central bank there surprised the market and raised rates by 2.0% rather than the 1.0% expected. So, like Brazil, despite economic concerns, inflation is rearing its ugly head. However, beyond that, last night saw strength in KRW (+0.6%) after the BOK indicated they will not allow excessive market volatility (read declines) in the wake of the FOMC meeting. And that was really the extent of the positives. On the downside, PLN (-0.9%) is the laggard, as the market is concerned over additional Covid closures slowing any comeback and encouraging easier monetary policy further into the future than previously thought. The rest of the CE4 are in similar, if not as dire straits this morning as the euro’s softness is undermining the whole group. As to LATAM, the peso is starting the day unchanged and the rest of the continent has not yet opened.
On the data front, today brings Initial Claims (exp 700K), Continuing Claims (4.034M), Philly Fed (23.3) and Leading Indicators (0.3%). In addition, we hear from the BOE, with no policy change expected, and then Chairman Powell speaks around noon at the BIS conference. My guess is that there will be a great deal of interest in what he has to say and if he tries to walk back the idea that the Fed is comfortable with the yield curve steepening as quickly as it is. One thing to recognize is that markets can move much faster than anticipated when given a green light. With the 10-year yield currently at 1.737%, a move to 2.0% by the end of the month is quite realistic. And my sense is that might raise a few eyebrows at the Mariner Eccles building.
As to the dollar, follow the yields. If they continue to rise, so will the dollar. If they stop, I expect the dollar will as well.
Good luck and stay safe