Headed into the new week, I suggested on multiple occasions that the market was on the brink of losing all faith in the Fed and that both equities and bonds would continue to bleed absent a compelling reason to believe policymakers are poised to get a handle on the inflation problem.
Those warnings were, unfortunately, borne out on Monday. Stocks and bonds were both beset, but the real drama came in the final hour, when the S&P extended losses and yields rocketed higher by as much as 36bps at the front-end.
The proximate cause of the late-day fireworks was a Nick Timiraos article. “A string of troubling inflation reports in recent days is likely to lead Federal Reserve officials to consider surprising markets with a larger-than-expected 75bps interest rate increase at their meeting this week,” he wrote, in a piece published after 3 PM in New York. Timiraos is, of course, the Journal‘s “Fed whisperer.”
Two-year yields went parabolic. The wild move up to ~3.40% came atop Friday’s 25bps jump, which already counted as the largest single-session increase since 2009.
It was difficult to find the right adjective to convey the gravity of the two-day move at the front-end. At one point, the two-session increase was ~60bps. As far as I can tell, the last comparable episode was four decades ago.
The figure (above) illustrates the magnitude in the context of the last two years.
I assume most readers are familiar with the dynamic. This is a tradition at the Journal. Fed whisperer articles are presented as recaps of recent public speaking engagements and other preexisting messaging. Technically, the articles contain no “new” information, but they’re widely viewed by market participants as leaks. That’s especially true when officials want to avoid blindsiding traders, but don’t have time to socialize the message. Bottom line: 75bps is on the table for Wednesday’s meeting.
The figure (below) illustrates the severity of what I think it’s fair to call an escalating crisis of confidence, but I’d emphasize that this is what the market needed. The slow bleed in equities and the tension in rates following May’s CPI report were indicative of extreme uncertainty about the Fed’s decision calculus. The Committee needs to address that uncertainty by (ironically) reclaiming their right to act without the market’s consent.
The near-term pain from a 75bps move (and, perhaps, aggressive messaging from Powell at the press conference), may well be acute, but markets will be better off for it over the medium-term. Or at least that’s my take.
Of course, the Timiraos story didn’t guarantee a 75bps increment this week. But it was most assuredly an indication that such a move is on the table and will remain so for July.
After flirting with the magic threshold for weeks, the S&P officially closed in a bear market on Monday (figure below).
The dollar surged and swaps priced a jumbo hike as a coin flip. Terminal rate pricing reached 4%.
“In the event the Committee errs on the side of predictability and delivers 50bps, there is little to justify two-year yields close to 3.25% other than the prospect for the Fed to, once again, need to play catch-up with faster hikes later this summer,” BMO’s Ian Lyngen and Ben Jeffery wrote. “While we’re certainly sympathetic to the optics of the Fed appearing behind the curve, larger rate increases at this juncture would primarily be symbolic and have a greater influence on breakevens and forward inflation expectations than actual gains in consumer prices during the coming months.”
I’d agree with that assessment. But the battle against inflation is already lost. The Fed is fighting the war now. If they want to win, they need to short circuit the expectations channel before it’s too late. 75bps would be a good start.