The bond market wasted little time taking Jerome Powell up on his implicit invitation to push US yields higher.
At the risk of resorting to hyperbole, it was something of a bloodbath by noon in the US. Intermediates paced losses on the curve and 10-year yields pushed up through 1.75%.
Tech shares weren’t amused. “Feels like [the] 10-year running to 2% is the ‘right move’ now with the US economy tracking ~6% in Q1,” Nomura’s Charlie McElligott said Thursday. “As such, secular growth (bond proxy) Nasdaq is being commensurately repriced lower relative to peers with more cyclical value / economic-sensitivity,” he added.
The figure (below) is simple, and is just meant to provide some context. The two red bars in November show growth’s woeful underperformance around Pfizer’s initial vaccine readout, while the red bar in January shows the same for “blue sweep” day.
Analysts were generally on the same page in terms of the implications from Powell’s express desire to see actual, realized inflation move higher prior to having any discussion about tightening.
“The curve will ultimately stretch steeper again,” ING’s Padhraic Garvey remarked, adding that “from a market rates perspective, the overall tone from the Fed leaves the back end of the curve largely unprotected. The impact on both ends of the curve has been jumpy.”
In keeping with commentary from Wednesday morning, McElligott called the bear steepening impulse predictable. “Regardless of the median 2023 dot” the market got the “green light” as Powell “simply stayed on message about not tightening ahead of meeting the employment and inflation mandates.”
Remember: “Meeting” those goals means something different now than it did previously. It’s no longer enough to bring inflation to target. The Fed wants to “make up” for past shortfalls, which means Powell needs to see a sustained overshoot. On employment, it’s all about inclusivity. There’s no set definition of what constitutes a sufficiently inclusive labor market. The Fed would appear to have considerable leeway when it comes to arguing that its goals in that regard haven’t been met, no matter where the headline unemployment rate is.
For their part, Goldman said that although the market clearly interpreted the Fed as dovish, the Committee’s reaction function is “somewhat ambiguous,” especially regarding the inflation threshold for liftoff.
“The dovish interpretation is that at least four participants out of the 11 who forecasted inflation of 2.1% or higher in 2023 saw that as insufficient for a rate hike, a group that likely includes at least part of the leadership,” the bank’s David Mericle wrote. “The hawkish interpretation is that this still appears to be a minority view on the FOMC, and that the main reason the median did not show a hike is that many participants still forecasted inflation at or below 2% in 2023, perhaps because they prefer to see more progress in the data before making larger upgrades to their forecasts.” For what it’s worth, Goldman left their projection unchanged. They expect liftoff in early 2024.
“2-handle 10s have become a much greater possibility in the wake of the FOMC’s dovish stance and the seasonals continue to favor higher yields for a while longer,” BMO’s Ian Lyngen and Ben Jeffery said Thursday, before noting that things are about to get complicated.
“With the 100 million vaccine doses milestone set to be reached this week, timelines for the return to in-person commerce have been intuitively brought forward [setting] the next several months up as the make or break period for the higher inflation scenario,” Lyngen and Jeffery added, noting that “the reckoning between inflation expectations and the realized data has been similarly accelerated [and] the timing corresponds with the base effects that come into play in March-May, leaving the year-over-year numbers distorted by the shutdowns to the point of irrelevance.”
When you toss in nearly a half-trillion in free money handed out to a public that’s suffering from a severe case of cabin fever, “the numbers could be tremendous,” as a “wise” man once said.
True to form, Rabobank’s Michael Every came up with something exceptionally colorful. “So yesterday was not the Fed-dy bears’ picnic. Rather, like some kind of macabre Monty Python sketch, the bears all turned up in their nice little waistcoats and boots…and were then devoured by the sandwiches,” he wrote. That said, Every observed that “the sandwiches [had] only won a single victory over the bears [and] more bears will be back – and this time with mustard and pickles and Sriracha sauce.”
The bond bears were back on Thursday, that’s for sure. And if 2% on 10s turns out to be a “in the next several sessions” thing as opposed to a “later this month” or “next month at the earliest” event, the bears could be back in equities too. Vaccines, reopenings and several hundred billion in “stimmy” notwithstanding.
And that’s to say nothing of what might happen in the event the data becomes too hot to ignore.
“We expect modest rates hikes in 2H23,” SocGen’s Stephen Gallagher wrote. “As COVID subsides in the second half of this year, more FOMC participants are likely to pull their hike expectations forward.”
Speaking to that, Nomura’s McElligott said “rates price-action should again remind us that the next phase will be a bear-flattener, as the market digests the pivot from ‘reflation’ to ‘tightening,’ with the Belly as the most acute ‘pain point’ into the QE tapering pull-forward.”
To be sure, not everyone was charitable with Powell. “It’s an old saying in financial markets that one’s view on an investment should change when the circumstances change,” JonesTrading’s Mike O’Rourke chided. The changes don’t necessarily have to be dramatic, “but a recognition of reality is important,” he went on to remark, before noting that “Powell usually fails to recognize shifts in market sentiment,” which means “the market must make sharp moves to wake him up, and his panicked response compounds one mistake after another.”
Bloomberg’s Cameron Crise, meanwhile, said Powell has “assum[ed] the mantle of ‘Bizarro Volcker.'”