Federal Reserve Jerome Powell testified during a Senate Banking Committee hearing on the “Quarterly CARES Act Report to Congress” on Capitol Hill in Washington, USA, December 1, 2020.
Susan Walsh | Reuters
Rising bond yields and inflation fears add a dramatic level to Federal Reserve Chairman Jerome Powell’s appearance this week before Congress.
The president of the central bank is to address the panels of the Senate and the House in the coming days as part of the mandatory half-yearly updates on monetary policy.
Normally, routine business, the recent financial market turmoil and concerns about how the Fed might react are prompting investors to pay a little more attention than usual to Tuesday and Wednesday’s hearings.
“This is one of the most interesting episodes in which a Fed chairman has had to testify,” said Nathan Sheets, chief economist at PGIM Fixed Income. “Sometimes we say ‘ho hum, no news.’ This will be news. He is really caught between a rock and a hard place. “
What has recently attracted market attention has been an increase in government bond yields, especially in the curve.
While the 2-year period is unchanged for 2021, the 5-year period has risen by almost a quarter percent since the market closed on Friday, while the 10-year benchmark has seen a 41-point increase in yield base at 1.34%, an area in which it was not about the same period in 2020, before the worst of the pandemics hit.
The 30-year bond yield has risen further, jumping by almost half a point this year to 2.14%.
Powell’s dilemma is that rising bond yields could signal the reflection of the economy that the Fed has boosted and is therefore greater for good reason. However, if the trend gets out of control, the Fed may have to tighten policy faster than the market expects, offsetting some of the good that came with the explosion in yields.
A complicated problem is that the markets may not like it if Powell is too satisfactory.
“If this testimony were behind closed doors, I think Jay Powell would be quite happy with what he sees in the economy and markets,” Sheets said, using the Fed president’s nickname. “But because it’s public, he has to be careful. If he’s too healthy about raising rates, markets will take this as a significant green light for rates to get higher.”
“The Fed is comfortable with an organic rate hike that reflects changes in views on growth and inflation,” he added. “But I think the Fed also wants to be careful not to create or amplify a self-sustaining dynamic that pushes rates higher for other reasons.”
These “other reasons” would be primarily fears that the economy could overheat.
Stimulus and more stimulus
The Fed has pursued a historically weak policy over the past year, lowering the reference lending rate to almost zero and buying at least $ 120 billion in bonds each month. It is at the top of a series of expired lending and liquidity programs since then, implemented in the early days of the Covid-19 crisis.
With that, Congress came up with more than $ 3 trillion in fiscal incentives and could approve up to $ 1.9 trillion more by the end of the week.
Everything that has happened against the background of an economy that, in addition to a still disturbing employment problem, primarily in the services sector, is humming. Wall Street is assuming growth expectations in the first quarter, and market inflation indicators are rising.
That’s why Powell’s rope ride this week will be all the more convincing.
“The market situation has changed,” Mohamed El-Erian, chief economic adviser at Allianz, told CNBC’s “Squawk Box.” It is no longer if yields will increase, it is the moment when the movement is too great. That’s what the market is trying to find out. “
Investors are particularly concerned that all incentives do not exceed the limits and threaten to destabilize the economy in the long run.
“I can predict that the yellow lights are flashing all over the Fed because of this [yields] moving and strengthening the yield curve, and the Fed could do more to try to control yields, “El-Erian said.
Fed officials have largely rejected so-called yield curve control to use their bond purchasing power to control rates between different fixed-income maturities.
But the market could force the Fed’s hand, and Powell is likely to be asked where he is in what tools the Fed has to calm market problems. He has repeatedly stressed that the Federation has the weapons to control inflation, but that they have a price. Low-yield markets and ordinary companies with cheap borrowing costs could be shaken by an unexpected Fed move.
Evidence of how clearly the market is following the issue came on Monday morning, when European Central Bank President Christine Lagarde said it was “closely monitoring the evolution of nominal long-term bond yields”. Her words were enough to calm a hectic market and turn what had been a loss of opening on Wall Street into a mixed market with Dow trading in the early afternoon. Treasury yields were largely fixed on that day.
Tom Lee, general partner and head of research at Fundstrat Global Advisors, said: “His clients have already expressed some concern about this week. Part of this reflects the fact that bond yields have risen steadily and stock investors are nervous that the bond market could reach a kind of “breaking point” during Powell’s testimony.
Powell is speaking to the Senate Finance Committee on Tuesday, and to the House Financial Services Committee on Wednesday.