Federal Reserve Jerome Powell testified during a Senate Banking Committee hearing on “The CARES Bill’s Quarterly Report to Congress” on Capitol Hill in Washington, USA, on December 1, 2020.
Susan Walsh | Reuters
The rising bond yields and accompanying inflation fears add a dramatic level to Federal Reserve Chairman Jerome Powell’s appearance before Congress this week.
The central bank presidency is scheduled to address the Senate and House panels in the coming days as part of the mandatory half-yearly updates on monetary policy.
Typically, routine issues, recent financial market turmoil, and concerns about how the Fed may react make investors pay a little more attention to the hearing of Tuesday and Wednesday hearings.
“This is one of the most interesting episodes in which he has had to declare a Fed chair,” said Nathan Sheets, chief economist at PGIM Fixed Income. “Sometimes we say ‘um, there’s no news.’ That’s going to be news. It’s really stuck between a rock and a hard place.”
What has recently caught the attention of the market has been a recovery in government bond yields, especially beyond the curve.
While the two years are unchanged for 2021, the five years have risen nearly a quarter of a percentage point at Friday’s market close, while the benchmark ten-year note has seen its performance rise 41 basis points. up to 1.34%, an area where it was not since the same time in 2020, before the worst of the pandemic occurred.
The yield on 30-year bonds has risen even further, jumping almost half the point this year to 2.14%.
Powell’s dilemma is this: rising bond yields could be indicating the reflection of the economy that the Fed has been pushing and are therefore higher for good reasons. However, if the trend goes out of control, the Fed may have to cut policy faster than the market expects, offsetting some of the good that has led to the burst of yields.
What complicates the matter is that the markets may not like it either if Powell is too complacent.
“If this testimony were behind closed doors, I think Jay Powell would be very pleased with what he sees in the economy and markets,” Sheets said, using the Fed chair’s nickname. “But given that it’s public, you have to be careful. If it’s too cheerful about rising rates, markets will see it as a significant green light for rates to recover.”
“The Fed is comfortable with an organic rate hike that reflects changes in views on growth and inflation,” he added. “But I think the Fed also wants to be careful not to create and amplify a self-sustaining dynamic that raises rates for other reasons.”
These “other reasons” would be mainly fears that the economy could overheat.
Stimulus and more stimulus
The Fed has maintained a historically weak policy over the past year, lowering its benchmark lending rate to almost zero and buying at least $ 120 billion in bonds each month. This is in addition to a number of loan and liquidity programs that have expired since then, implemented in the early days of the Covid-19 crisis.
Along with that, Congress has come up with more than $ 3 trillion in fiscal stimulus and could approve up to $ 1.9 trillion more over the weekend.
Everything that has transpired in the midst of an economy that, in addition to a still worrying employment problem, mainly in the services sector, is humming. Wall Street is assuming first-quarter growth expectations and market-based inflation indicators are rising.
That’s why Powell’s loose rope this week will be even more compelling.
“The mood of the market has changed,” Mohamed El-Erian, Allianz’s chief economic adviser on CNBC’s “Squawk Box,” said Monday. It is no longer if yields increase, it is when the movement is too great. That’s what the market is trying to figure out. “
Investors are especially concerned about whether all the stimulus is not exceeded and threatens to destabilize the economy in the long run.
“I can predict that the yellow lights are blinking across the Fed because of the Fed [yields] the movement and the rise in the yield curve, and the Fed can do more to try to control yields, ”El-Erian said.
Fed officials have largely ruled out the so-called control of the yield curve to use its bond purchasing power to control rates between various fixed-income maturities.
But the market could force the hand of the Fed, and Powell is likely to be asked about what tools the Fed has to calm market problems. He has repeatedly reiterated that the Fed has the weapons to control inflation, but deploying them comes at a price. Markets accustomed to low yields and companies accustomed to cheap borrowing costs could be hampered by an unexpected Fed move.
Evidence of the clarity that the market is seeing the issue came Monday morning, when European Central Bank President Christine Lagarde said she was “closely monitoring the evolution of long-term nominal bond yields. ”. His words were enough to calm a nervous market and turn what had been a loss of opening on Wall Street into a mixed market with the Dow until trading in the early afternoon. Treasury yields were mostly flat on the day.
Tom Lee, managing partner and head of research at Fundstrat Global Advisors, noted that his “clients have already expressed some concern about this week. Part of this reflects the fact that bond yields have steadily increased and that investors equities are nervous that the bond market could reach a sort of “breaking point” during Powell’s testimony.
Powell speaks Tuesday in the Senate Finance Committee on Wednesday in the House Financial Services Committee.