Yields, Bonds, and Stocks
The reason we’re going to talk about bonds is because the ten-year treasury entered last week at 1.4 yield. At one point during the last week of February, it had gone above a 1.6 yield. This is interesting because we actually got to see the way in which the stock markets sold off when the ten-year treasury got above 1.5.
Now that we know where the line in the sand is, the question that remains then is…
Will the volatility continue?
My thought to that is yes, very likely. It’s going to carry into the beginning of March and one thing is definitely certain in terms of what the message. The bond market’s screaming at the equity markets and specifically the Federal Reserve.
That’s that we are challenging the way in which they think it’s okay to run the U S economy as hot as it is, and push that 2% inflation number. In fact, being willing to over shoot it.
The beginning of March is probably not going to be a calm and smooth up trend. Right now investors and traders are focusing on the way in which the Federal Reserve (and frankly, other central banks around the world) are going to respond.
This is a question about tone.
Not anything in terms of actual shifts in monetary policy. However if they sound nervous about the way in which bond yields have started to move the equity markets, we’ll probably see this volatility in stocks continue.
What would be a typical reaction if the Federal Reserve wants to soothe the bond market, and inturn, also soothe the equity markets?
They’d likely, again with tone, start to signal that they’re clearly in no rush to temper. Remember the temper tantrum that we’ve seen in previous years, the market still remembers that pretty clearly. So, if they start to signal that they’re willing to delay temper and even beyond what’s expected right now, we’ll probably see the equity markets pretty content.
That tone alone, would probably stop the climb in bond yields to 1.6% again, and even beyond in its tracks.
Now, one thing we probably won’t see the Federal Reserve do is a repeat of what they did during the 2013 temper tantrum. If you recall back then, Fed officials seemed to be fine with higher rates. Their argument, and what they tried to convince the market of, was that higher rates actually reflected the much improved fundamentals of the economy.
That didn’t end so well…
I don’t see the Fed trying that approach again.
In fact, the Fed actually overshot interest rates. That, once again, became something that the Fed had to, sort of unring that bell. To recap, the benchmark 10 year treasury yield surpassed1.5% sending equities lower. To reflect that, traders and investors are actually betting that the Federal Reserve is going to have to act sooner rather than later.
This, in terms, is what’s known as a tightening policy which is essentially hiking rates.
Countdown Fun Fact: Again, any insinuation of higher rates the equity markets are going to hate.
Even though Jerome Powell made it very clear that they have no near term plans to raise rates, one of the things that they cited was a little bit of slack in the labor market. Clearly the bond market doesn’t believe that can be true. They believe the Fed will be forced to shorten the time frame to ultimate rate hikes.
At a Wall Street Journal event, Jerome Powell will certainly be asked to comment about the bond market. Investors and traders are going to definitely be looking for Powell to make some public comments before the mid month policy meeting.
This is important because there’s still a couple of weeks left before the Federal Reserve releases their statement. I expect Powell, and a steady stream of Fed members, to make comments. They may want to calm the markets down around their expectations about the market overheating and their response to that possibility.
That’s where the battle is going to be fought whether or not the statements that are made before the meeting can calm the bond market down.
One easy way to track this for traders who like this, is to view the 10 year minus the three month treasury. What you’ll notice is that the trajectory of the 10 year minus the three months has been moving sharply higher.
Again, that 1.5 level is one that I’d keep a very close eye on in terms of stock market weakness.