The worst bond selloff on record accelerated Wednesday, with the usual caveat that the move was vulnerable to being faded over the US session, especially considering the presence of a tradable event (the March Fed minutes).
Notwithstanding the potential for any “buy the news” trade on the minutes, global yields pushed higher on the heels of remarks from Lael Brainard, who emphasized US policymakers’ determination to proceed with what she described as “methodical” rate hikes and “rapid” balance sheet runoff.
Yields in the UK, Germany, Australia and New Zealand all surged. 10-year Aussie yields are the highest since 2015. Earlier this week, the RBA dropped a reference to “patience” in its policy statement, suggesting rate hikes could commence in the coming months.
In the US, 10-year yields were back to territory seen throughout 2018 (simple figure below), a year during which cash was the best performing (traditional) asset on the planet.
In Q4 of that fateful year, Jerome Powell discovered policy wasn’t as far away from neutral as he figured when he committed his most infamous communications “sin.” Or at least not if you adopt a perverse definition of “neutral,” replacing any reference to employment and prices with stocks and credit spreads.
At the time, US real rates exceeded 1% and 10-year nominals were north of 3.10%. But the threshold beyond which real rate rise impacts stocks seems to have drifted lower over time, consistent with multiples which rose in lockstep with the decline in reals (eventually into deeply negative territory). As for nominals, it’s not necessarily about the level, but rather the rapidity of the move. I say that over and over again.
Currently, the 30-day change in nominals is a three-standard deviation move. Typically, that bodes very poorly for equities.
“Tactically, the speed of the move in interest rates has crossed the two standard deviation threshold, which has historically been a headwind to equity returns,” Goldman noted. “The one-month change in rates registered +3 standard deviations in nominal terms and +2 standard deviations in real terms,” the bank’s David Kostin wrote. The figure (above) illustrates the point.
I talked a bit on Tuesday about the extent to which the Fed’s hiking plans (and market pricing) appear to suggest a material overshoot of neutral when taken in conjunction with the tightening impulse from balance sheet runoff.
The figure (below) gives you a sense of what I meant. The orange bar assumes 250bps of rate hikes — basically the March hike plus market expectations. The teal bar is just the change in the shadow rate in January and February.
I don’t see how that’s achievable considering the likely read through for markets, which are off to an egregious start in 2022. Stocks, credit and especially bonds, are all struggling. A Fed that hikes 50bps at three of the remaining six policy meetings (with “regular” hikes at the other three) while running down the balance sheet rapidly will end up delivering an “off the charts” tightening impulse.
Do note: That wouldn’t happen in a vacuum. Almost invariably, stocks would remain stuck in a kind of rolling, bearish quagmire, which would exert a tightening impulse of its own, as would any widening in credit spreads. Dollar strength and persistently elevated long-end yields would be insult to injury.
This isn’t tenable. Something’s going to break sooner or later. Probably sooner.
I hope you all enjoyed Bill Dudley’s interview on Bloomberg TV this morning. He explicitly stated that Fed policies would send stocks “much lower” and bond yields ‘much higher”.
He also explicitly said that the Fed is targeting wage growth. The last question was why current and former Fed officials were so quiet about this goal, he answered something like “no one wants to say they are trying to keep wages from rising.”
A quick survey of the biographies of the loudest proponents of a rapid removal of stimulus at the Fed reveals zero.zero private sector experience. None.
How can we expect them to understand the tangled web of financial engineering that will unravel as interest rates rise much higher? Even Alan Greenspan, who claimed to be a great student of the markets, allowed investment banks to increase their leverage to 40 times. Remember that? That surely helped usher in the GFC a few years later.
If only I were wired to be a trader and not a LT investor….. I am destined to ride out yet another harrowing roller coaster ride.
I am not selling (in spite of alarm bells going off) because I won’t know when to get back in. No big purchases for me in 2022.
Are you there, Jerome? It’s me, Emptynester.
I can only say that circumstances, and the actions of Jerome Powell to date as Fed chair, do not inspire my confidence. I don’t imagine we’ll be able to shake off the effects of Jerome Powell’s leadership until late next year or early 2024. If I were Joe Biden, I’d fire Powell in 2023. Powell can take the blame for the errors of his ways while leading the Fed. And I cannot be sorry to see him go. By firing him, Biden will stand up for his constituents, who will be in a sour mood from months of inflation and economic impacts from the war with Russia, which we hope (Please!) will be resolved by then.