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All eyes will be on the Federal Reserve meeting next week as traders put pressure on the central bank to prevent a destabilizing rise in bond yields.
Still, the US central bank will likely stay true to its message that higher yields reflect a more favorable economic outlook, suggesting that the clash between recalcitrant bond traders and a patient central bank will continue.
“The Fed is aiming for higher inflation, which means higher interest rates. I think the market misinterpreted the Fed when it came to controlling the yield curve, ”Steven Ricchiuto, chief US economist at Mizuho, said in email comments.
The central bank’s reluctance to push back speculation in the bond market ended up undermining investor sentiment, with the sharp rise in long-term bond yields this year causing a momentary panic in tech stocks, corporate bonds and financial markets. Emerging Markets.
Some of these market nerves reflect fears that a further disorderly rise in long-term yields could cripple a recovering and heavily indebted economy ill-prepared for rising borrowing costs.
The 10-year US Treasury bill yields TMUBMUSD10Y,
rose to around one year of 1.63% at the end of the week, the benchmark maturity is up around 70 basis points where it traded in early 2021.
Meanwhile, the S&P 500 SPX,
and Dow DJIA,
finished at another record high on Friday, after rebounding from last week’s slump when investors were rocked by the prospect of selling more in the bond market.
Analysts predict Fed Chairman Jerome Powell will repeat the mantra that the central bank falls short of meeting employment and inflation targets at his press conference after the March 17 policy meeting .
Perhaps more aptly, the Fed is unlikely to respond to calls from bond traders to announce adjustments to the additional leverage ratio, which was adjusted last year to help banks cope with the coronavirus crisis, or to change the composition of its monthly purchases of US Treasuries. and mortgage bonds.
“They will resist being pushed around. The last thing they want to do is fight the market. As long as [the rise in yields] is orderly and as long as the credit markets are functioning well, the Fed gets what it wants, ”Gregory Staples, North America fixed income manager at DWS, told MarketWatch.
See: Fed to stay easygoing next week as Powell channels his inner calm from Gary Cooper
Yet one of the places where investors can see the central bank move closer to the bond market’s view of the economy is in the summary of economic projections and the so-called dot plot, where members of the Fed’s decision-making committee forecast the direction of key interest rates. .
December’s dot chart shows that most FOMC members are marking their first rate hike in 2024.
With a $ 1.9 trillion stimulus bill now signed by President Joe Biden, some senior Fed officials may choose to move their planned timeline for the first interest rate hike since the start of the pandemic in 2023. But such a decision is still far from the market. more belligerent expectations, with short-term money markets marking a rate hike by the end of 2022.
“This creates a gap between the Fed’s projections and the market projections,” Lauren Goodwin, economist and portfolio strategist at New York Life Investments, told MarketWatch.
Still, it’s unclear whether this tension has the potential to cause further turmoil in the market as it has in recent weeks, according to Jefferies’ Aneta Markowska.
She argued that the steep sell-off in the bond market has so far reached levels that indicate investors have already digested the economic boost from the stimulus bill. Until the Fed started the conversation about reducing its asset purchases, it didn’t see yields rise.
Ultimately, the heated debate over which direction interest rates will take could prove to be a side show for stock investors momentarily stunned by the rise in long-term bond yields.
If the rise in bond yields reflects a surge in economic growth, corporate earnings should improve significantly, making higher borrowing costs less relevant to the equity market.
“Rates don’t have to stay at historically low levels for earnings to improve,” Goodwin said.
Next week, investors will digest some major US economic data releases, including February retail sales and industrial production on Tuesday and February housing starts on Wednesday.
The timetable for releasing corporate results will be slim, although a handful of large companies may attract attention. Nike Inc. NKE,
Accenture PLC ACN,
and Fedex Corp. FDX,
will report the results next week.
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