Fed could be a source of volatility as Powell speaks the week ahead

The Federal Reserve could remain a source of angst for markets in the week ahead, with President Jerome Powell scheduled to testify twice before Congress and more than a dozen more Fed speeches expected.

The bond market’s reaction to the central bank last week has been unusually volatile.

Although the market was initially flat after the two-day Fed meeting and Powell’s briefing on Wednesday, Thursday came with a big bond sell-off and a surge in rates. Traders have responded to the central bank’s readiness to let inflation and the economy overheat while the labor market recovers.

In the coming week, bond market professionals will be watching Powell and other members of the Fed for more clues.

“These are bonds – I wouldn’t call it a day in the sun – it’s more like a day in the tornado,” said Michael Schumacher, head of rate strategy at Wells Fargo. “It is clear that the bond market is where the stock market is currently watching, and normally it is not.”

Stocks were down for the week, with the Dow Jones down about 0.5% and the S&P 500 down 0.7%. The Nasdaq Composite was down 0.8% for the week.

The Russell 2000, however, was the hardest hit, losing nearly 3% for the week.

Yields increased as the market sold. Bond yields move inversely with price.

The yield on benchmark 10-year Treasury bills, which impacts mortgages and other loans, hit 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 it’s starting to scare people,” Schumacher said.

“There was this question hanging out there for a while: How much increase in yield can some of the higher octane stocks take?” He asked. “There’s no magic number, but as we speak the 10-year is up 80 basis points this year. It’s amazing.”

Powell is testifying Tuesday and Wednesday before congressional committees with Treasury Secretary Janet Yellen on Covid relief efforts and the economy.

He also speaks about the central bank’s innovation at a Bank for International Settlements event on Monday morning.

Other central bank speakers this week include Fed Vice Chairman Richard Clarida, Vice Chairman Randal Quarles, Fed Governor Lael Brainard and New York Fed Chairman John Williams.

There is also some key data.

Important releases include Friday’s consumption and personal spending data, which includes the PCE deflator, the Fed’s preferred measure of inflation. Core PCE inflation was running at an annual rate of 1.5% in January.

The Federal Reserve last week took no 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 forecast now shows PCE inflation going to 2.4% this year, but falling to 2% next year.

The majority of Fed officials saw no interest rate hikes until 2023.

Powell reiterated that the Fed sees only a temporary pick-up 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 range around 2%, so that number could exceed that threshold for some time. This is a change in the basic rules of the Fed, which is making the bond market nervous.

Normally, the Fed would raise interest rates if inflation rose to prevent the economy from overheating and avoiding a cycle of recession.

“For the bond market and the Fed, there is a communication problem and a consensus problem. There cannot be tension,” said Diane Swonk, chief economist at Grant Thornton.

“They will try to clarify the Fed’s message, but without consensus on what these numbers and safeguards mean, it will be difficult,” she said. “They will explain themselves as economists, and they will speak a different language than what the bond market speaks.”

Leo Grohowski, chief investment officer at BNY Mellon Wealth Management, expects the bond market to be more volatile than stocks, and inflation would be problematic for both.

At some point, he expects there to be a 10% market correction, and inflation or a sharp move in bond yields could be a trigger.

“The market is trying to make sense of what might be seen as a disconnect, between their economic projections and the Fed’s dual tenure of unemployment and inflation,” Grohowski said.

“Still, they have pledged to keep short rates in abeyance until the end of 2023,” he said. “This is what the market struggles with. I think it’s troubling for me to hear words like ‘overshoot’.”

Grohowski expects what he calls the “big rotation” from technology and growth stocks to cyclical stocks and value to continue. Growth and technology were the most sensitive to the rate hike, and the Nasdaq corrected more than 10%.

“I think we’re in the sixth or seventh inning of a nine-end game. It’s not over, but I think we’ve seen the lion’s share of the big rotation out of the growth, in value “said Grohowski. He said that this view depends on the 10-year not much exceeding 1.75%.

Grohowski is concerned about the Fed’s willingness to let inflation exceed because inflation is negative for stocks.

Supply chain issues are a matter of concern. He highlighted comments from Nike on Thursday that its sales had been affected by port congestion, as well as the semiconductor shortage, which is impacting auto production.

“Inflation expectations are embarrassing for P / E [price-earnings] ratios, ”said Grohowski. [stock] the market is trading at 22 times our estimate of this year’s earnings. “

He said the market was struggling to reconcile the lack of an expected interest rate hike with the strength of the Fed’s economic forecast.

“If you ask me why I’m losing sleep?… That’s too much of a good thing. Too much of a good thing is being too accommodating,” Grohowski said.

Schumacher said there is a chance the bond market will stabilize over the next two weeks, even if yields rise.

He said corporate pension funds appear likely to reallocate capital to bonds before the quarter ends on March 31, which could be favorable. Additionally, as the Japanese fiscal year is about to begin, there could also be further purchases of US Treasuries as, on a currency adjusted basis, US debt looks very cheap, Schumacher said.

He is also monitoring Treasury auctions in the coming week.

The Treasury is auctioning $ 60 billion 2-year notes on Tuesday; $ 61 billion in 5-year notes on Wednesday and $ 62 billion in 7-year notes on Thursday.

In particular, Schumacher is looking at the 7-year auction, which drew low demand last month.

Monday

Earnings: Tencent Music Entertainment

9:00 a.m .: Jerome Powell, Fed Chairman, at the Bank for International Settlement summit

10:00 a.m. Sales of existing homes

10:00 a.m. Quarterly Financial Report

1:00 p.m. Mary Daly, President of the San Francisco Fed

1:30 p.m. Randal Quarles, Vice-President of the Fed

7:15 p.m. Fed Governor Michelle Bowman

Tuesday

Earnings: Adobe, IHS Markit, DouYu, GameStop, Steelcase

8:30 am Current account

9 a.m. James Bullard, President of the Saint-Louis Fed

10:00 am Sales of new homes

12:00 p.m. Fed Chairman, Treasury Secretary Janet Yellen at the House Financial Services Committee

1:00 p.m. Treasury auction of $ 60 billion in 2-year bills

1:25 p.m. Fed Governor Lael Brainard

1:45 p.m. New York Fed President John Williams

3:45 p.m. Brainard, Fed Governor

4:20 p.m. Saint-Louis Fed Bullard

Wednesday

Earnings: General Mills, Shoe Carnival, KB Home, RH, Tencent, Embraer, Winnebago

8:30 am Durable goods

9:45 a.m. Manufacturing PMI

9.45 a.m. PMI Services

10:00 a.m .: Powell, Chairman of the Fed, and Secretary of the Treasury Yellen, at the Senate Banking Committee

1:00 p.m. 5-year $ 61 billion note auction

1:35 p.m. New York Fed Williams

3:00 p.m. San Francisco Fed Daly

7:00 p.m .: Charles Evans, President of the Chicago Fed

Thursday

Earnings: Darden Restaurants

5:30 a.m. New York Fed Williams

8:30 a.m. Initial complaints

8:30 a.m., third reading of Q4 GDP

10:10 a.m., Fed Vice President Richard Clarida

10:30 a.m. New York Fed Williams

1:00 p.m. Treasury auction of $ 62 billion in 7-year bills

1:00 p.m. Chicago Fed Evans

7:00 p.m. San Francisco Fed Daly

Friday

8:30 a.m. Personal income / expenses

8:30 a.m. Leading economic indicators

10:00 a.m. Consumer sentiment