Markets Have Mini-Tantrum Over Powell Remarks; Yields Rise

Well, Jerome Powell’s pandemic honeymoon period appears to be over. His address at the WSJ Forum was followed by significant market carnage. It’s not like he did or said anything blatantly wrong; he didn’t. Sometimes though, the role of a Fed Chairman is quite thankless. The adoring crowd can quickly turn into a hostile and demanding one. By and large he completely stuck to the common script. He took the position that any increases in inflation that we would see would most likely be transitory and that he expected the Fed to essentially ignore them. The Fed is still not even ‘thinking about thinking’ raising rates or curtailing asset purchases according to Powell and his deputies.

Rates spiked in the wake of Powell’s remarks which apparently weren’t dovish enough. Despite the turmoil in equity and spike in yields yesterday many indicators of financial stability the Fed pays closest attention to like risk premiums on corporates are still in great shape.

We spoke with some experts yesterday who believed by opening up a ‘crack’ in the Fed’s current dovish stance by indicating it could be altered by incoming data increased existing anxieties. Essentially, this means their response could be forced by bond market participants. We expect the Fed might work to fix this miscommunication with markets, which is likely what it was. While this is extremely inside baseball, one thing is clear the market is paying attention to diverging narratives from the Fed and the futures market for short-term rates; the former is saying rates won’t rise for three years and the latter is saying they will likely rise at the beginning of 2023.

Another contributing factor was some recent Treasury auctions on February 25th. The maturities that had weaker-than-expected demand are those typically considered sensitive to expectations about Fed policy. The seven-year had its lowest bid-to-cover ratio experienced at an auction of its’ kind in more than ten years. The fact that liquidity in the bond market seems to be lacking in the wake of recent volatility is also not helping the situation.

Expectations for a robust real-economy recovery, perhaps the likes of which we haven’t seen in this century, have become baseline at this point and Fed officials say this is why rates are rising; it’s good. However, if the economic momentum surprises to the upside the Fed may be forced to raise rates early which could result in a higher peak of interest rates than the market currently expects. This would start to make bonds relatively more attractive to equities, particularly the Growth/Defensives that act as bond proxies, and is thus a problem for those who want to see equity indexes continue marching higher. The expectations for low rates is a pillar of valuation in many of the high-flying, high P/E ratio FAANG/Technology names.

However, we’d like to point out that a lot of ‘Epicenter’ and cyclical names tend to benefit in a reflationary, cyclical economic expansion. For the past year, when there was a market-wide ‘risk-off’ sentiment cyclicals would experience nasty downside and Growth/Defensives would continue melting up. However, the market action of the last weeks has seen the opposite occur. Investors are rotating into cyclicals from growth.

Asset purchases continued at a pace of $40 billion a month for MBS and $80 billion a month for Treasuries. The benchmark yield on the 10 year is up to 1.577% from 1.407% last week.

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