Often it is what is left unsaid that deserves the most attention.
Federal Reserve Chairman Jerome Powell’s decision to sidestep the issue of inflation and rate hikes at a central bank conference in Stockholm this week, as markets bet against his previous hawkish signals, could prove as pivotal as his late August speech in Jackson Hole when he snuffed out a summer rally with gloomy projections and a vow to continue to tighten.
Despite Fed meeting minutes warning that rates will rise past 5% and stay there for some time, Fed governors’ suggestions for short-term hikes in media interviews and recent Powell’s warnings about the risks of runaway consumer price risks, stock and bond markets continued to test the central bank’s overarching inflation-fighting message.
The S&P 500 has risen about 3.36% since late December, a modest gain from last year’s sharp 20% decline, but nonetheless telling in the face of hawkish warnings from the Fed.
CME Group’s FedWatch, meanwhile, puts the odds of a 25 basis point hike in central bank rates on Feb. 1 at 79.2%, with bets on a potential rate cut emerging at the meeting. of September from the Fed.
Benchmark 2-year bond yields, which closed at 4.403% at the end of December, fell to around 4.21% amid easing wage pressures in the labor market, a dismal assessment of the Services-sector activity from the ISM survey and bets on a subdued December inflation reading from the Commerce Department later this week.
That’s a far, far cry from the Fed’s projection of a fed funds rate north of 5%, which it sees hitting in early spring, and echoes FedWatch’s rate hike bets that not only see rates peak below 5%, but expected rate reductions in the second half of the year.
So who do we believe?
Jeffrey Gundlach, the well-known bond investor who runs DoubleLine Capital, has few doubts: “My over 40 years of experience in finance strongly advises investors to watch what the market is saying rather than what the Fed is saying,” said he said during a webcast on Tuesday evening.
That view could be tested today, in fact, as the Treasury prepares to auction $32 billion worth of 10-year notes as part of its ongoing funding operations.
The auction, a re-opening of a previous issue, will provide a real-time benchmark for fixed-income appetite ahead of tomorrow’s December CPI reading, which is expected to show a sixth straight month of easing price pressures.
If bidders buy the new paper, it could suggest 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.
In fact, bond markets have been signaling a recession for some time, with 3-month treasury yields hovering around 1.14% north of 10-year treasuries, the largest “reversal” in the yield curve since the early 1980s.
Job growth is expected to slow sharply in the coming months, after the addition of 4.5 million new workers last year, the housing market continues to recover and a survey closely followed, the sentiment of small business owners fell to its lowest level since 2013 last month.
Others, however, note that bond markets have “cried wolf” about recession in the past, and rightly argue that economic models do not always reflect the growing complexity of a globalized world.
“The consumer is still spending and with businesses still hiring at a strong pace, there’s a chance we could avoid an economic downturn and not an outright contraction,” said Lawrence Gillum, fixed income strategist for LPL Financial in Charlotte, North Carolina.
“It’s also important to point out that the last time the 3-month/10-year yield curve was inverted, the economy fell into recession due to a global pandemic – something we would say didn’t. factored into the reversal, but she still gets ‘credit’ for the signal,” he added.
Powell, who focused on central bank independence and the need for a defined mandate from lawmakers during Tuesday’s speech in Sweden, has remained curiously silent in the recent debate.
And if he continues to allow markets to price in lower rate hikes, a lower spike and cuts in the second half of the year, he’s either comfortable with that forecast or ready. to let it run and let the inflation data do the pushback work for him.
This could be a major risk.
Chairman Powell has made it clear that the Fed will not lead the next inflation cut,” said Ian Shepherdson of Pantheon Macroeconomics, who sees core CPI slowing to around 2% by the middle of the year. they can ignore it once it’s clear to the markets that the downturn is real.”
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