Federal Reserve Chairman Jerome Powell listens to a hearing of the Senate Banking Committee on the Quarterly CARES Act Report to Congress on Capitol Hill in Washington, United States, on Dec. 1, 2020.
Susan Walsh | Reuters
The Federal Reserve could remain a source of fear for the markets for the week ahead. Chairman Jerome Powell is due to testify twice in Congress, and more than a dozen other Fed speeches are expected.
The bond market’s response to the central bank over the past week has been unusually volatile.
Although the market was initially stable after the two-day Fed meeting and Powell’s briefing on Wednesday, there was a sharp sell-off in bonds and peak interest rates on Thursday. Traders reacted to the fact that the central bank is poised to let inflation and the economy run hot while the labor market rebounds.
For the coming week, bond market pros will be watching Powell and other members of the Fed for further clues.
“These are bonds – I wouldn’t call it a day in the sun – it’s more like a day in a tornado,” said Michael Schumacher, director of interest rate strategy at Wells Fargo. “It is clear that the bond market is what the stock market is watching right now, and usually it isn’t.”
Stocks were lower over the week, with the Dow down about 0.5% and the S&P 500 down 0.7%. The Nasdaq Composite fell 0.8% for the week.
However, the Russell 2000 was hit the hardest, losing nearly 3% in the week.
Returns rose when the market sold out. Bond yields move in reverse to price.
The benchmark 10-year government bond yield, which affects mortgages and other credit, rose to 1.75% on Thursday, a move of more than 10 basis points in less than a day. It was 1.72% on Friday afternoon.
“The bond movement was huge and is slowly making people afraid,” said Schumacher.
“That has been the question for a while: How much increase in earnings can some of the higher octane stocks handle?” he asked. “There’s no magic number, but as we speak, the 10 years have increased 80 basis points this year. It’s incredible.”
Powell speaks
Powell testifies Tuesday and Wednesday before the congressional committees with Treasury Secretary Janet Yellen about Covid’s relief efforts and the economy.
He also speaks about central bank innovations at an event hosted by the Bank for International Settlements on Monday morning.
Other Fed Speakers this week include Fed Vice Chairman Richard Clarida, Vice Chairman Randal Quarles, Fed Governor Lael Brainard, and New York Fed President John Williams.
Inflation and the Fed
There are also some key dates.
Key releases include Friday’s personal consumption and expenditure data, including the PCE deflator, the Fed’s preferred inflationary measure. Core PCE inflation was at an annual rate of 1.5% in January.
The Federal Reserve took no action at its two-day meeting last week, but it did come up with new economic forecasts, including a forecast of 6.5% for gross domestic product this year. The central bank’s forecast now shows that PCE inflation will rise to 2.4% this year, but to 2% next year.
The majority of Fed officials saw no rate hikes until 2023.
Powell reiterated that the Fed sees only a temporary pickup in inflation this year due to base effects year-on-year and falling prices.
The central bank is aiming for an average inflation range of around 2%, so that number could exceed this threshold for some time. It is a change in the Fed’s basic rules that is making the bond market nervous.
Ordinarily, when inflation rose, the Fed would raise interest rates to avoid overheating the economy and stave off a bust cycle.
“There is a communication problem and a consensus problem for the bond market and the Fed. There can be no tension,” said Diane Swonk, chief economist at Grant Thornton.
“They will try to get the Fed’s message across, but without a consensus on what these numbers and guard rails mean, it will be difficult,” she said. “They will declare themselves as economists and speak a different language than the bond market.”
Leo Grohowski, chief investment officer at BNY Mellon Wealth Management, expects the bond market could be more volatile than stocks, and inflation would be problematic for both.
At some point, he anticipates a 10% correction in the equity markets, and inflation or a sharp move in bond yields could be a trigger.
“The market is trying to understand what could be seen as the disconnect between their economic projections and the Fed’s dual mandate on unemployment and inflation,” Grohowski said.
“Still, they are determined to keep short rates on hold until the end of 2023,” he said. “The market is struggling with that. I find it troubling to hear words like ‘overshoot’.”
Rotation from tech to cyclicals
Grohowski expects the technology and growth stock he calls the “big rotation” to continue into cyclical values and value. Growth and technology were the most sensitive to rising rates, with the Nasdaq correcting more than 10%.
“I think we’re in the sixth or seventh inning of a nine-inning game. It’s not over yet, but I think we’ve seen the lion’s share of the big rotation from growth to value,” said Grohowski. He said the view hinges on the 10 year mark not rising much above 1.75%.
Grohowski is concerned about the Fed’s willingness to let inflation rise as inflation is negative for stocks.
Problems in the supply chain are a matter of concern. He pointed to Nike’s comments on Thursday that sales were being hurt by the congestion in ports and the shortage of semiconductors affecting auto production.
“Inflation expectations are problematic for the P / E ratio [price-earnings] Conditions, “said Grohowski [stock] The market is trading at 22 times our estimate for this year’s earnings. “
He said the market is struggling to reconcile the lack of forecast rate hikes with the strength of the Fed’s economic forecast.
“If you ask me what I’m losing sleep over? … It’s too much of a good thing. Too much of a good thing is to be too accommodating,” said Grohowski.
Bond market direction
Schumacher said there was a chance the bond market could stabilize over the next few weeks even if yields rose.
He said occupational pension funds are likely to reallocate capital to bonds before the end of the quarter, March 31, and that could be supportive. New US government bonds could also be bought at the start of the Japanese fiscal year, as US debt looks very cheap after currency adjustments, Schumacher said.
In the coming week he will also be watching treasury auctions.
The Treasury Department is auctioning $ 60 billion worth of 2-year bonds on Tuesday. $ 61 billion in 5-year debt on Wednesday and $ 62 billion in 7-year debt on Thursday.
In particular, Schumacher is watching the 7-year auction, which saw weak demand last month.
Calendar for the week ahead
Monday
Merits: Tencent Music Entertainment
9:00 am Fed Chairman Jerome Powell at the Bank for International Settlements Summit
10:00 am Existing home sales
10:00 a.m. Quarterly Financial Report
1:00 p.m. Mary Daly, San Francisco Fed President
1:30 p.m. Randal Quarles, vice chairman of the Fed
7:15 p.m. Fed Governor Michelle Bowman
Tuesday
Merits: Adobe, IHS Markit, DouYu, GameStop, Steelcase
8:30 a.m. current account
9:00 am James Bullard, St. Louis Fed President
10:00 am Sale of new houses
12:00 noon Fed Chairman Powell, Treasury Secretary Janet Yellen on the House Financial Services Committee
1:00 p.m. Treasury Auctions $ 60 Billion 2-Year Notes
1:25 p.m. Fed Governor Lael Brainard
1:45 p.m. John Williams, President of the New York Fed
3:45 p.m. Fed Governor Brainard
4:20 p.m. St. Louis Fed’s Bullard
Wednesday
Merits: General Mills, Shoe Carnival, KB Home, RH, Tencent, Embraer, Winnebago
8:30 a.m. consumer goods
9:45 am Manufacturing PMI
9:45 a.m. Services PMI
10:00 am Fed Chairman Powell, Treasury Secretary Yellen on the Senate Banking Committee
1:00 p.m. Treasury Auctions $ 61 Billion 5-Year Notes
1:35 p.m. Williams at the New York Fed
3:00 p.m. Daly from the San Francisco Fed
7:00 p.m. Charles Evans, President of the Chicago Fed
Thursday
Merits: Darden restaurants
5:30 a.m. Williams from the New York Fed
8:30 a.m. first claims
8:30 a.m. Q4 BIP third reading
10:10 am Richard Clarida, vice chairman of the Fed
10:30 a.m. Williams from the New York Fed
1:00 p.m. Treasury Auctions $ 62 Billion 7-Year Notes
1:00 p.m. Evans at the Chicago Fed
7:00 p.m. Daly from the San Francisco Fed
Friday
8:30 a.m. Personal Income / Expenses
8:30 a.m. leading indicators
10:00 am consumer mood
