Now It’s Jay Powell’s Turn to Speak
Federal Reserve chairman Jay Powell’s speaking engagement on March 4 is, in Horizon’s view, critical for the central bank’s messaging and credibility, and for taming the bond market selloff.
The problem Powell needs to deal with head on is this: some people in the bond market think economic growth will be fast enough, and inflation high enough, to prompt the Fed to tighten policy much earlier than they say they will. The lurch higher in short-term rate expectations – and the dynamics that are driving it – is posing a credibility issue that Powell needs to address.
That lack of belief in the Fed’s low-rate promise is clear when looking at how many rate increases are now priced in for 2023 (3 hikes) and 2024 (5 hikes) using eurodollar contracts – despite the Fed’s current pledge to keep rates pinned to zero until at least the end of 2023.
Behind the Curve
The challenge for Powell is to convince markets that the Fed will not wait so long to address inflation that it will be in a panic to catch up. The recent selloff in fixed-income markets signaled that change in market opinion, as shown in the chart below. Up until mid-February, inflation was expected to increase, but real – or inflation adjusted – yields were tumbling, meaning traders saw no danger to asset prices. However, in the middle of last month, markets became concerned the Fed might rush to raise rates in the face of strong inflation, as shown by the jump in real yields. The prospect of a Fed falling behind the curve is why the specter of another $1.9 trillion in economic stimulus may have set off alarm bells among some on Wall Street. It certainly didn’t help that some famous economists warned of just such a scenario.
From Buyer’s Strike to Buying Frenzy?
The stage is set for there to be fireworks in markets during Powell’s appearance. But it all rests on how firmly he pushes back against the doubters.
A forceful Powell defense Thursday could bring in yield-starved investors off the sidelines, and perhaps a buying spree. From Horizon’s vantage point, there was a buyer’s strike in bonds last week. The clearest example is the terrible demand at the auction of 7-year Treasury notes – which caused 10-year Treasury yields to briefly spike to 1.6%.
If Powell should falter, markets may quickly send bond yields higher and tighten financial conditions, damaging the Fed’s aim to keep monetary policy as loose as possible to foster a recovery. Such a scenario also suggests that it would be even more difficult for the Fed to squash the sceptics.
In Horizon’s view, now is the time for Powell to be bold as he takes on Wall Street’s bond bears and attempts to restore calm to global markets. If not, he risks a disorderly adjustment in prices as investors race to update their portfolios to reflect the possibility of higher interest rates much sooner than anyone expected.
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This commentary is written by Horizon Investments’ asset management team. For additional commentary and media interviews, contact Chief Investment Officer Scott Ladner at 704-919-3602 or firstname.lastname@example.org.
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