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Investors are likely to weigh every word of Federal Reserve Chairman Jerome Powell this week to see if he is bowing to pressure to suspend interest rate hikes planned by the central bank.
Powell's speech on Wednesday, along with that of his number two, Richard Clarida, on Tuesday, will bring back the spotlight on the flattening of the yield curve, a reliable indicator of the bond market for future recessions. These remarks will strike critics, including President Donald Trump, who have called on the Fed to slow its rate hike as stocks stumble and global growth slows.
Fluctuations in the curve could indicate how the markets anticipate the central bank's reaction to the tug of war between a robust US economy and investors' pessimism about its long-term prospects.
"The appearance of Powell on Wednesday will test his determination to continue standardization [interest rates] the recurrent weakness of the stock market, "writes Ward McCarthy, chief financial economist for Jefferies.
See: Trump asks the Fed to reduce its interest rates after the wipeout of the stock market, but the story is not on his side
Equities struggled as worries about tighter monetary policy offset strong earnings and buybacks. Until Friday, the S & P 500
SPX, + 1.47%
down 10.2% and the Dow Jones Industrial Average
DJIA, + 1.37%
was 9.5% from record highs, say FactSet data.
The bond market also expressed concern over the tightening of the Fed's path.
Analysts say the yield curve, illustrated by the gap between short-term and long-term returns, has resumed flattening as the bond market feared that Fed rate hikes would dampen growth. In other words, market players fear that the central bank may make a mistake by raising rates when tariffs and the slowdown in the global economy show signs of loss of profitability and corporate spending.
Lily: Stock Market Investors Send Fed Chairman Jerome Powell a Clear Message
John Herrmann, MUFG Securities' rate strategist, said the central bank should suspend its rate hike cycle in the first half of next year to avoid an economic slowdown in 2020.
After a brief expansion in October, several measures of the yield curve were reduced to pre-recession levels. In the spirit of the market, this raises the specter of the dreaded reversal of the curve, which, once triggered, was historically followed by an economic crisis.
The difference between the yield of the note at 2 years
TMUBMUSD02Y, + 0.59%
and the 10-year note yield
TMUBMUSD10Y, + 0.81%
, a popular means of measuring the slope of the curve, stood at 24 basis points on Friday, near its 10-basis-point low of the decade, in August.
And another measure, the gap between the 10-year bill and the 3-month bill
TMUBMUSD03M, -0.11%
fell to 65 basis points at the end of last week, its narrowest level since 2008. A model that calculated recession probabilities on the basis of the magnitude of this gap estimated the probability of recession. an economic slowdown in late October 2019 around 14%, its highest level. levels since the 2007-09 recession, according to the New York Fed.
Powell and Clarida seemed to acknowledge Wall Street's concerns in another recent comment, citing weak economic growth abroad as a factor likely to complicate the Fed's plan to continue with a steady rate hike.
Traders have praised their comments as the central bank was making a turnaround, re-launching expectations of several rate hikes in 2019. The futures market for federal funds, where traders can bet on the direction of the rates of interest rates, is likely to be a problem. reference interest, now shows that market players do not expect that a hikes next year, from forecasts for three hikes in place a month ago.
If Powell reiterates his concerns about the health of the global economy and lists other risks to the normalization of monetary policy, short-term returns, which closely follow the path of the Fed, could contract and accentuate the yield curve.
Also check: Traders betting on a dovish Fed have it all wrong: the SocGen economist
But market observers believe, in Powell's mind, that the sharp correction of equities will weigh less than the low unemployment rate in the United States. overheating of the labor market. To avoid such a panicky policy response, the Fed may be able to consider that continued rate hikes are a better way to expand US economic expansion than to remain upright, even if equities do not recover.
"We believe that Powell and Co. would be more willing to look at the excesses of risky assets at this stage of the cycle in order to avoid overburdening the economy," said Ian Lyngen, head of the rate strategy. US interest at BMO Capital Markets. , in a note on Monday.
The US unemployment rate stood at 3.7% in October, its lowest level since 1969. Economic growth remains strong, with the United States growing by 2.9% this year.
If Powell agrees with the scenario of the need to tighten policies so that growth remains sustainable, the yield curve should flatten out, Lyngen said.
Short-term returns will continue to rise and increase borrowing costs, which will weigh on the economy. In this gloomy context, long-term returns will struggle to recover.
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