“We think the 20bps flattening in the curve since the Fed looks extreme and was likely driven by a positioning washout following the FOMC,” TD’s Priya Misra said Monday, in the course of reinitiating a 5s30s steepener just days after abandoning one.
It was emblematic of what I’ll (very aptly) call a “reversal of the reversal.” What was true early last week wasn’t true once the Fed unveiled the new dot plot, but after a weekend of soul searching (go ahead and chuckle), market participants (carbon-based and otherwise) decided the post-FOMC trade wasn’t true either.
Was any of it true in the first place? Who knows. Probably not. As I put it early Monday, “there’s a difference between the market getting caught wrong-footed (in steepeners, for example) and having to unwind and otherwise de-leverage, and leaning into new trades seen as consistent with the Fed’s pivot.”
Monday’s bear steepening marked a rather dramatic turnaround not just from last week’s dramatic flattening, but even from the earliest action in the new week, when it looked as though the duration rally was set to extend meaningfully. The 5s30s re-steepened by nearly 9bps on the day (figure below).
“A simple regression suggests the curve could re-steepen above 145bps if TIPS BEs remain unchanged,” TD went on to say, adding that “curve positioning could be much cleaner now and there are a few fundamental reasons for re-steepening” including, of course, supply and the assumption the Fed is nowhere near hiking rates.
Although comments from Jim Bullard and Robert Kaplan were somewhat ambiguous Monday (they’re clearly focused on averting an inflation spiral, but outside of that, their remarks offered little in the way of new information), John Williams stuck to a dovish script, noting risks “on both sides” of the Fed’s employment and price mandates.
“From my perspective, we’re quite a ways off from achieving my interpretation of ‘substantial further progress’,” Williams said, adding that,
There are obviously upside risks to inflation. On the downside, I think there are two. One is if there were a weaker economic recovery – – either, for whatever reason domestically, but I think maybe even more likely internationally, if the global economy struggles more than expected in its recovery, that could spill over to the US recovery. The other is this reversal process — and I don’t see this as a factor that will drive inflation for years, but it can affect inflation next year — that a big part of the big increases in prices over the last two months have been in relative prices of goods. And those relative prices, like used cars and things like that, they’re not going to stay at those super-elevated levels forever. Supply and demand will adjust over time. That time might be a couple years. We don’t know. But if that happens quicker than you’d expect, then those price increases that pushed inflation up will actually pull inflation down next year. You could see, actually, inflation coming in lower than expected if that happens much more quickly than expected.
If you were looking for the counterpoint to the new “hawkish Fed” narrative, there it is.
Later, the Fed released Jerome Powell’s Tuesday testimony on the Fed’s coronavirus response. He repeated himself, as he’s wont to do. “Inflation has increased notably in recent months,” Powell will tell lawmakers. “This reflects, in part, the very low readings from early in the pandemic falling out of the calculation; the pass-through of past increases in oil prices to consumer energy prices; the rebound in spending as the economy continues to reopen; and the exacerbating factor of supply bottlenecks, which have limited how quickly production in some sectors can respond in the near term,” he added, on the way to predicting that once “these transitory supply effects abate, inflation is expected to drop back toward our longer-run goal.”
“This week’s series of Fed-speakers will help further refine investors’ understanding of the FOMC’s recent less-dovish pivot,” BMO’s US rates team said Monday afternoon.
“While it certainly follows intuitively that the market would be intently focused on the central bank’s interpretation of the balance of risks facing the US recovery, it is still rare that the official commentary possesses as much US rates moving potential as it does at this moment,” the bank’s Ian Lyngen and Ben Jeffery remarked.
For everyday investors, keeping apprised of every utterance from Fed officials is tedious. It’s also mostly pointless, most of the time. But, as Lyngen and Jeffery emphasized, now is not “most of the time.” Now, every turn of phrase counts.
That’s an unfortunate state of affairs for those who prefer to spend their days poring over the “fundamentals” or, I don’t know, doing anything other than listening to technocrats debate each other (and the market) over the proper year to raise interest rates from zero to a level slightly above, but still very close to, zero.
Meanwhile, the Cleveland Fed is using Lego towns to explain the situation to the public.
“Have you ever been shopping and noticed that the prices of things you buy have gone up?,” one of three “Inflation 101” videos posted to bank’s official website asks. “If the same things in your shopping basket cost $100 last year and now they cost $105, that’s ‘inflation.'”
“Lego people scream as a narrator describes hyperinflation, where prices increase at uncontrollable levels, before they’re reassured that the Fed’s got things under control,” Bloomberg wrote, recounting a bad day in Legoland (clip below).
I’m not sure what it says about the American public when the Fed determines the most effective way to communicate important concepts to ostensible adults is to use Legos.
Actually, I’m quite sure what that says about the American public, but since I can’t find a polite euphemism, I’ll refrain.