US markets have morphed into something that resembles the cryptosphere, with outsized daily swings the norm and calm sessions the exception.
Equities have become such a cartoonish farce that sales desks are tired of talking about it, while rates are similarly unpredictable. A rapid reassessment of Fed pricing amid the conflict in Ukraine collided with lopsided (hawkish) positioning to produce front-end fireworks earlier this week, but on Wednesday, Treasurys tumbled amid Jerome Powell’s Congressional testimony.
Generally speaking, Powell was hawkish. Traders lifted bets on the trajectory of Fed hikes in 2022 has he spoke, after paring them aggressively amid the Ukraine drama. “While nailing the coffin on a 50bps move at the March meeting, Powell opened up the possibility of super-sized rate hikes further out in this years rate cycle,” Bloomberg’s Edward Bolingbroke wrote, noting that eurodollar futures spreads “ripped” after that, “with a particular hat tip to the March 2022/December 2022 curve which has now widened as much as 25bps on the day.”
Alluding to the same front-end fireworks detailed in the linked post above, Bolingbroke called this “a torrid time for eurodollar traders.”
As noted, Powell all but confirmed that liftoff will be a “regular” 25bps point hike, but he also tipped the possibility of larger increments down the road. He backed “a series of rate increases,” said supply-side constraints have proved much more durable than expected, called inflation “nothing like” what we’ve experienced in decades, admitted the Fed can’t call the turn and said the housing market should cool off (just like Zoltan suggested he might).
There were, of course, the obligatory nods to being careful along the road to normalizing policy, but it’d be a (bad) mistake to call Powell’s testimony dovish. It wasn’t. Consider this passage:
To the extent that inflation comes in higher or is more persistently high than that, then we would be prepared to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings.
If Powell had said that at a press conference in 2021, risk assets would’ve likely recoiled in horror. Note that he also alluded to the prospect of taking policy into restrictive territory. “It may well be that we need to go higher than [neutral],” he said. “We just don’t know.”
Again: Powell was hawkish. Equities may have liked confirmation that March won’t be 50bps and that the Fed doesn’t intend to cause a recession, but that’s not news. By Wednesday, swaps weren’t even pricing in a full 25bps.
“It was time for the resumption of Fed hawkish messaging on tightening policy, and Powell delivered, from his comments keeping 50bps alive as an option down the road, his heavy emphasis on upside inflation risks and downplaying negative US growth implications of Ukraine, it was on the money,” Nomura’s Charlie McElligott said, in a late Wednesday note, before suggesting the fireworks mentioned above likely increased the sense of urgency around reiterating the Fed’s intentions to get moving. And don’t forget that the recent widening in breakevens pushed reals back lower (i.e., more negative), the opposite of what the Committee needs.
“The two-day rates VaR event forced a liquidation in hawkish trades that created a dovish optic, no doubt, but with FCI easing so insanely the last few weeks, inflation still accelerating and labor hot too, the Fed has no choice but to lay the lumber and pivot the market back towards a hawkish liftoff path,” McElligott said.
After the largest two-day decline since the financial crisis, policy-sensitive yields exploded 20bps higher on Wednesday (figure below).
And just like that, the bear flattening was back, and the hawkish trade looked set to resume.
“The Treasury curve bear flattened as Powell confirmed that the situation in eastern Europe will not derail the Committee from following through with the first hike of the cycle on March 16,” BMO’s Ian Lyngen and Ben Jeffery wrote. “The Chair certainly left the possibility for 50bps on the table at a later meeting in the event inflation doesn’t come into line.”
As for risk assets (which, for the vast majority of market participants, just means “stocks”), McElligott called Powell’s hopeful messaging about cooler inflation in the second half a “local win.”
If you ask Powell himself, he’s going to land this plane. Not only that, he suggested market participants are wrong to assert that almost no Fed tightening cycles end well.
“I think that it is more likely than not that we can achieve what we call a soft landing,” Powell told lawmakers. “They are far more common in our history than is generally understood.”
I read it totally differently (deleted comments aside).
He’s saying nothing is set in stone, and that a series of rate hikes is not some sort of fate accompli. It’s the perfect Fed speak — lets the hawks believe that the Fed is willing to do whatever it takes (as long as the data shows the necessity), let the doves know that nothing is set in stone. Previously there was a sense that the hikes were happening no matter what, perhaps that we’d even start off with 50 bps.
Russia has been a gift, it offers perfect cover for not hiking aggressively right out of the gate. Why else would the narrative change so dramatically in a ~6% inflation environment?
Powell has never endorsed starting with 50, so no change there, and he has never explicitly suggested 50s down the line, so a change there.
I am interested to see when he starts opening the door to outright sales. Pressure to restrain housing inflation is rising and he is increasingly acknowledging the Fed’s limited tools there. He certainly knows that the biggest tool in the Fed’s box is actively selling MBS.
Anyway, in two weeks the tightening actions (not just words) starts and the Fed appears prepared to keep tightening relentlessly at every meeting.
In my mind, Fed rate adjustments have little to do with reality these days and MBS sales are unlikely to matter in any way.
One way to put this in perspective is to contrast the vast trillions of QE over 10 years then look at Fed rate adjustments, which are essentially microscopic. Additionally, contrast mortgage yields or even 10 year treasury yields against the home value or equity gains over 20 years.
If mortgage rates go over 5 percent as a result of Fed jawboning in the next year, will that really impact home prices? Increased rates will impact lower income people that are already priced out of home ownership, but in my warped vision, we’re headed towards a time when fewer people will use mortgages. As prices continue to rise, cash will play a larger role and create new risks …
I thought Poiwell had banished the term “auto-pilot” from his lexicon, but he trotted it out again today (although at least in the context of saying “never” again). I’d like to see him retire “framework” next, as it seems essentially meaningless. Reminds me when I asked a lawyer how the brief was coming along and ne told me it was mentally drafted.
The testimony looks neutral to me. They will go 25, wait and go again if they need to…. rinse and repeat. That is how monetary policy usually works. With all that is going on- it really is the only way to fly. Note that there is probably going to be a chopped down version of build back better coming to a Congress near you….
Manchin’s latest comments suggest it’ll be called “Build A Teeny Bit Back And Forget About The Better”.