There are “massive days ahead,” Nomura’s Charlie McElligott said Tuesday, as the March FOMC loomed large on the horizon.
The tension between the Fed and the bond market was palpable (to say the least) headed into this week, and any pre-Fed “calm” was probably better characterized as a kind of nervous paralysis. Or, better still, an old-West-style staring contest at high noon.
As discussed at some length in “Until Something Breaks?,” there are multiple dynamics in play, from the backup at the long-end and the ramifications for financial conditions, to the market’s pricing for the rate path.
The dots present a “credibility conundrum,” McElligott said Tuesday, noting that although “the market [is] anticipating and pricing a 2023 liftoff… Bloomberg consensus of Street economists [isn’t] expecting the Fed [to] reflect this in their median forecast.”
It goes without saying that if there is a subtle “hawkish” (and “hawkish” is as relative a term as relative terms get) shift in the dots with no accompanying indication from Jerome Powell that the Fed is poised to address the laundry list of additional concerns the market harbors, it could be knee-jerk bearish for risk assets, especially stocks.
“It would be higher yields for ‘tightening’ and not ‘higher growth- / inflation- expectations,'” McElligott went on to say, before suggesting that “ultimately” that would represent “a much healthier outcome for both rates and equities.” It would at least help settle the disconnect (read: disagreement) between the market and the Fed on the rate path.
When it comes to the simpler question of how high 10-year yields need to get before stocks really take note, the March edition of BofA’s global fund manager survey suggests 2% is the threshold. “Nobody believed that rates at 1.5% would cause an equity correction,” the bank’s Michael Hartnett said. “But the move from 1.5% to 2% is critical as 43% of investors now think 2% is the level of reckoning in the 10-year Treasury that will cause a 10% correction in stocks.”
“The market will keep testing the Fed by pushing rates higher,” Hartnett’s colleague Mark Cabana said earlier this month, suggesting the Fed will be “forcibly stopped into the bond market with more aggressive balance sheet use” but only to “address market functioning and liquidity issues” rather than “macroeconomic ones.”
That’s always the excuse, isn’t it? “We had to intervene due to market functioning.”
While there’s a lot to be said for citing market functioning and liquidity when you need plausible deniability to tweak policy, it’s undoubtedly true that the Fed is loath to upset stocks. Equities are the sacred cow, even as no policymaker wants to admit as much.
So, it’s possible the Fed will simply stick with it. It there’s no movement in the median dot, McElligott said “the equities party may gap higher, with the largest $Gamma strike at Spooz 4,000 being easily in play and beyond.”
Meanwhile, Morgan Stanley’s Matthew Hornbach reckoned the Fed would try to allay concerns about “early” rate hikes. Any pushback from Powell in that regard would likely mean “investor fear about an earlier exit from accommodative policy subside[s], presenting a tactical opportunity to buy the bond market.”
Any further “partying” (for stocks) or dip-buying (in bonds) would be welcome in the near-term, but depending on how the Fed communicates, the Committee risks preserving some elements of the above-mentioned “staring contest.” As McElligott wrote, “the standoff in rates market-pricing versus the Fed [would] only grow wider and force an eventually dangerous reckoning.”
In other words, can-kicking is potentially perilous. But central banks have perfected it over the years. Depending on your definition of “perfected.”
