Federal Reserve Chairman Jerome Powell listens during a Senate Banking Committee hearing on “Quarterly CARES Report to Congress” on Capitol Hill in Washington, USA, December 1, 2020.
Susan Walsh | Reuters
The Federal Reserve could remain a source of concern for markets next week, with President Jerome Powell testifying twice before Congress and expecting more than a dozen other Fed speeches.
The reaction of the bond market to the central bank in the last week has been unusually volatile.
Although the market was initially stable after the two-day Fed meeting and Powell’s briefing on Wednesday, Thursday came with a large bond sale and growth rates. Traders have reacted to the central bank’s willingness to let inflation and the economy heat up as the labor market recovers.
In the coming week, bond market professionals will follow Powell and the other Fed member for more information.
“This is an obligation – I wouldn’t call it a sunny day – it’s more like a tornado day,” said Michael Schumacher, head of tariff strategy at Wells Fargo. “Clearly, the bond market is the one the capital market is looking for right now, and that’s not normally the case.”
Stocks were lower for the week, with the Dow down about 0.5% and the S&P 500 down 0.7%. Nasdaq Composite was down 0.8% for the week.
However, Russell 2000 was the hardest hit, losing almost 3% a week.
Yields increased as the market sold. Bond yields are reversed from price.
The 10-year Treasury benchmark yield, which affects mortgages and other loans, rose to 1.75% on Thursday, a move of more than 10 basis points in less than a day. It was 1.72% on Friday afternoon.
“The bond movement has been huge and is starting to scare people,” Schumacher said.
“This question has been around for some time: how much can the yield of some of the largest octane stocks increase?” he asked. “There’s no magic number, but as we talk, 10 years have grown by 80 basis points this year. It’s incredible.”
Powell is speaking
Powell testified Tuesday and Wednesday before congressional committees, along with Treasury Secretary Janet Yellen, about efforts to help Covid and the economy.
He also talks about central bank innovation at a Bank for International Settlements event on Monday morning.
Other central bank speakers this week include Richard Clarida, Fed Vice President, Vice President Randal Quarles, Fed Governor Lael Brainard and New York Fed President John Williams.
Inflation and the Fed
There are also some key data.
Important releases include Friday’s personal consumption and spending data, which includes the PCE deflator, the Fed’s preferred measure of inflation. PCE core inflation was at an annual rate of 1.5% in January.
The Federal Reserve last week did not take any action at its two-day meeting, but presented new economic projections, including a 6.5% forecast for gross domestic product this year. The central bank’s forecast now shows that PCE inflation will go to 2.4% this year, but will fall to 2% next year.
Most Fed officials have not seen any interest rate hikes until 2023.
Powell reiterated that the Fed sees only a temporary rise in inflation this year due to base effects compared to last year’s figures when prices fell.
The central bank will target an average inflation rate of around 2%, so that this number could exceed that threshold for a period of time. It’s a change in the Fed’s ground rules, which makes the bond market nervous.
Normally, the Fed would raise interest rates if inflation exploded to avoid an overheated economy and to avoid the error cycle.
“For the bond market and the Fed, there is a communications issue and there is a consensus issue. There can be no tension,” said Diane Swonk, chief economist at Grant Thornton.
“They will try to clarify the Fed’s message, but without a consensus on what those numbers and bumpers mean, it will be difficult,” she said. “They will explain themselves as economists and speak in a language other than the bond market.”
Leo Grohowski, chief investment officer at BNY Mellon Wealth Management, expects the bond market to be more volatile than equities, and inflation would be problematic for both.
At some point, he expects a 10% correction in the stock market, and inflation or a sharp move in bond yields could be a trigger.
“The market is trying to understand what might be perceived as a disconnect between their economic projections and the Fed’s dual mandate of unemployment and inflation,” Grohowski said.
“However, they have pledged to keep rates short until the end of 2023,” he said. “That’s what the market is struggling with. I think it’s annoying for me to hear words like ‘overtaking.'”
Rotation from technology to cyclical
Grohowski expects what he calls the “big rotation” of technology stocks and cyclical growth and value to continue. Growth and technology were the most sensitive to rising rates, and the Nasdaq corrected more than 10%.
“I think we’re in the sixth or seventh inning of a nine-inning game. It’s not over, but I think we’ve seen the lion’s share of the big rotation out of growth, in value,” Grohowski said. He said the vision depends on 10 years not growing much above 1.75%.
Grohowski is concerned about the Fed’s willingness to let inflation exceed, as inflation is negative for stocks.
Supply chain issues are a concern. He pointed out Nike’s comments on Thursday that its sales were affected by port congestion and also by the shortage of semiconductors, which affect car production.
“Inflation expectations are troubling for the P / E [price-earnings] “said Grohowski.” [stock] the market trades 22 times our estimate for this year’s gains. “
He said the market is struggling to reconcile the lack of any projected interest rate hikes against the strength of the Fed’s economic forecast.
“If you ask me why I’m losing sleep? … It’s too much of a good thing. Too much is a good thing to be too accommodating,” Grohowski said.
Bond market direction
Schumacher said there is a chance that the bond market will stabilize in the next few weeks, even as yields rise.
He said corporate pension funds appear to be redistributing bond capital before the end of March 31, and this could be supportive. Also, as the Japanese fiscal year begins, there could also be new acquisitions in U.S. treasuries because, on a currency-adjusted basis, U.S. debt looks very cheap, Schumacher said.
It is also following the Treasury auctions next week.
The Treasury is bidding on $ 60 billion worth of tickets on Tuesday; $ 61 billion in 5-year tickets on Wednesday and $ 62 billion in 7-year tickets on Thursday.
In particular, Schumacher is following the 7-year-old auction, which attracted weak demand last month.
The calendar of the week before
months
Earnings: Tencent Music Entertainment
9:00 a.m. Fed Chairman Jerome Powell at the Bank for International Settlement Summit
10:00 am Sales of existing homes
10:00 am Quarterly financial report
13:00 Mary Daly, President of the San Francisco Fed
1:30 pm Fed Vice President Randal Quarles
19:15 Fed Governor Michelle Bowman
Tuesday
income: Adobe, IHS Markit, DouYu, GameStop, Steelcase
8:30 Current account
9:00 am James Bullard, President of the St. Louis Fed
10:00 am New home sales
12:00 pm Fed Chairman Powell, Treasury Secretary Janet Yellen on the House Financial Services Committee
1:00 pm Treasury bids $ 60 billion for two years
13:25 Fed Governor Lael Brainard
13:45 John Williams, President of the New York Fed
15:45 Fed Governor Brainard
16:20 Fed Bullard St. Louis
Wednesday
Earnings: General Mills, Shoe Carnival, KB Home, RH, Tencent, Embraer, Winnebago
8:30 am Durable goods
9:45 PMI manufacturing
9:45 PM PMI Services
10:00 am Fed Chairman Powell, Secretary of the Treasury Yellen to the Senate Banking Committee
1:00 pm The Treasury is bidding $ 5 billion on 5-year banknotes
13:35 Williams Fed of New York
15:00 Daly Fed from San Francisco
19:00 President of the Chicago Federation, Charles Evans
Thursday
Earnings: Darden Restaurant
5:30 am Williams from the New York Federation
8:30 am Initial claims
8:30 am Q4 GDP third reading
10:10 a.m. Fed Vice President Richard Clarida
10:30 am Williams from the New York Federation
13:00 Treasury auctions $ 62 billion banknotes over 7 years
13:00 Evans Fed Fed of Chicago
19:00 Daly Fed from San Francisco
Friday
8:30 am Personal income / expenses
8:30 am Advanced economic indicators
10:00 am Consumer sentiment