Often, it’s what is not said that deserves essentially the most attention.
Federal Reserve Chairman Jerome Powell’s decision to sidestep the problem of inflation and rate hikes during a central banking conference in Stockholm this week, as markets bet against his previous hawkish signals, may prove as pivotal as his late August speech in Jackson Hole when he snuffed out a summertime rally with gloomy projections and a vow to hold on tightening.
Despite minutes from Fed meetings warning that rates will rise past 5%, and stay there for a while, suggestions of near-term hikes from Fed Governors in media interviews and Powell’s recent warnings on the risks of unchecked consumer price risks, stock and bond markets have continued to check the central bank’s overall inflation-fighting message.
The S&P 500 has risen around 3.36% since late December, a modest gain compared to last 12 months’s brutal 20% decline, but nonetheless telling within the face of the Fed’s hawkish warnings.
The CME Group’s FedWatch, meanwhile, is pricing in a 79.2% probability of a 25 basis point rate hike from the central bank on February 1, with bets on a possible rate cut emerging within the Fed’s September meeting.
Benchmark 2-year note yields, which closed at 4.403% at the tip of December, have fallen to around 4.21% amid easing wage pressures within the job market, a grim assessment of services sector activity from the ISM survey and bets on a tame December inflation reading from the Commerce Department later this week.
That sits a protracted, good distance from the Fed’s projection of a Fed Funds rate that is north of 5%, which it sees hitting in early spring, and echoes rate hike bets from FedWatch that not only see rates peaking below 5%, but forecast rate cuts over the second half of the 12 months.
So who can we imagine?
Jeffrey Gundlach, the famed bond investor who runs DoubleLine Capital, has few doubts: “My 40 plus years of experience in finance strongly recommends that investors should take a look at what the market says over what the Fed says,” he told a webcast late Tuesday.
That view could possibly be tested today, in truth, because the Treasury prepares to auction $32 billion 10-year notes as a 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 anticipated to indicate a sixth consecutive month of easing price pressures.
If bidders snap-up the brand new paper, it could suggest they’re less concerned about inflation pressures and more anxious about growth prospects, particularly now that investors view a near-term recession as a 50/50 bet.
Bond markets, in truth, have been signaling recession for quite a while, as yields on 3 month Treasury bills sit some 1.14% north of 10-year notes, the steepest ‘inversion’ of the yield curve because the early Nineteen Eighties.
Job growth is forecast to slow sharply over the approaching months, following the addition of 4.5 million recent employees last 12 months, the housing market continues to roll over and a closely-tracked survey small business owner sentiment fell to the bottom levels since 2013 last month.
Others, nonetheless, note that bond markets have ‘cried wolf’ on recession up to now, and accurately argue that economic models don’t at all times capture the increasing complexity of a globalized world.
“The buyer remains to be spending and with businesses still hiring at an elevated clip, there’s a probability that we will skirt by with an economic slowdown and never an outright contraction,” said Lawrence Gillum, fixed income strategist for LPL Financial in Charlotte, North Carolina.
“It’s also vital to indicate that the last time the 3-month/10year yield curve was inverted, the economy fell right into a recession due to a world pandemic—something we’d argue was not priced into the inversion yet it still gets ‘credit’ for the signal,” he added.
Powell, who focused on central bank independence and the necessity for an outlined mandate from lawmakers during Tuesday’s speech in Sweden, has remained curiously silent on this recent debate.
And if he continues to permit markets to price-in smaller rate hikes, a lower peak and cuts over the back half of the 12 months, he’s either comfortable with that forecast and willing to let it run and let inflation data do the push-back work for him.
That could possibly be a serious risk.
Chair
Powell has made it abundantly clear that the Fed is not going to
be front-running the approaching drop in inflation,” said Ian Shepherdson of Pantheon Macroeconomics, who sees core CPI slowing to around 2% by the center of the 12 months. “But neither
will they have the opportunity to disregard it once it becomes clear to
markets that the downshift is real.”