It is often the unsaid that deserves the most attention.
Federal Reserve Chairman Jerome Powell’s decision to sidestep the issue of inflation and interest rate hikes during this week’s central bank conference in Stockholm could be as important as his Jackson Hole speech in late August, as markets bet against his earlier hawkish signals. a summer rally with gloomy forecasts and a promise of continued tightening.
Despite warnings in Fed meeting minutes that interest rates will cross 5% and stay there for some time, Fed Governors’ near-term hike proposals in media interviews and Powell’s recent warnings about the risks of out-of-control consumer prices and the risks to stock and bond markets have continued to test the central bank’s general inflation-fighting message. continued.
The S&P 500 is up about 3.36% since the end of December, a modest gain compared to last year’s brutal 20% decline, but still showing that in the face of the Fed’s hawkish warnings.
Meanwhile, CME Group’s FedWatch puts the odds of a 25-basis-point rate hike from the central bank on February 1 at 79.2%, with bets on a potential rate cut emerging at the Fed’s September meeting.
The yield on 2-year notes, which closed at 4.403% at the end of December, fell to around 4.21% on the back of easing wage pressures in the labor market, a poor assessment of service sector activity from the ISM survey and lonely December bets. An inflation reading from the Commerce Department later this week.
That’s a far cry from the Fed’s forecast for a Fed Funds rate north of 5%, which it hit in early spring, and reflects FedWatch’s rate hike bets, which not only see rates peaking below 5%, but the forecast rate shows the degree. deficit in the second half of the year.
But who do we believe?
Jeffrey Gundlach, a well-known bond investor who runs DoubleLine Capital, is a little skeptical: “My more than 40 years of experience in finance advises investors to look at what the market is saying rather than what the Fed is saying,” he said.
That view could be put to the test today as the Treasury prepares to auction $32 billion of 10-year notes as part of ongoing financing operations.
The auction, a reopening of the previous issue, will provide a real-time indication of appetite for fixed income ahead of tomorrow’s December CPI reading, which is expected to show the sixth consecutive month of easing price pressures.
If bidders file a new filing, it could indicate they are less concerned about inflationary pressures and more concerned about growth prospects, especially now that investors view a near-term recession as a 50/50 bet.
Bond markets have, in fact, been signaling recession for quite some time now, with 3-month Treasury yields hovering around 1.14% north of 10-year notes, the steepest yield curve “inversion” since the early 1980s.
After adding 4.5 million new workers last year, the housing market continues to fluctuate, and small business owner sentiment fell to its lowest level since 2013 last month in a closely watched survey.
Others note that bond markets have “cryed the wolf” in the past about recessions, and rightly argue that economic models do not always capture the increasing complexity of a globalized world.
“If the consumer is still spending and businesses are still hiring at a high level, there’s a chance we’re going to go through an outright contraction rather than an economic slowdown,” said Lawrence Gillum, fixed-income strategist for LPL Financial in Charlotte, North Carolina. Carolina.
“It’s also important to note that the last time the 3-month/10-year yield curve inverted, the economy was in recession due to the global pandemic — something we’d argue didn’t price the inversion, but still gets credit for the signal,” he said.
Powell, who emphasized central bank independence and the need for a mandate from lawmakers during a speech in Sweden on Tuesday, was curiously silent in this latest debate.
And if he continues to allow markets to see smaller rate hikes, a lower peak and cuts in the second half of the year, he’s either comfortable with that forecast and willing to let it play out and let the inflation data do its job of pulling back. for him.
This can be a big risk.
Chairman Powell has made it clear that the Fed will not pre-empt further declines in inflation,” said Ian Shepherdson of Pantheon Macroeconomics, which sees core CPI slowing to around 2% mid-year. “But there won’t be any. Once it becomes clear to markets that the decline is real, they may ignore it.”