The Fed could be a source of volatility as Powell talks next week

The Federal Reserve could remain a source of distress for markets next week, with President Jerome Powell testifying twice before Congress and more than a dozen Fed speeches expected.

The reaction of the bond market to the central bank last week was unusually volatile.

While the market initially remained stable after the Fed’s two-day meeting and Powell’s briefing on Wednesday, Thursday came with a big bond sell-off and growth rates. Traders reacted to the fact that the central bank is willing to let inflation and the economy heat up as the labor market recovers.

In the next week, bond market professionals will be waiting for Powell and other Fed members for more clues.

“This is a link,” I wouldn’t say “in the sun,” it’s more like tornado day, ”said Michael Schumacher, head of Wells Fargo’s rate strategy. which is watching the equity market right now, and it usually isn’t. “

Shares were lower for the week, with the Dow down around 0.5% and the S&P 500 down 0.7%. The Nasdaq Composite fell 0.8% during the week.

However, the Russell 2000 was the hardest hit and lost about 3% during the week.

Yields increased as the market sold. Bond yields move inversely to price.

The 10-year benchmark cash yield, which affects mortgages and other loans, rose to 1.75% on Thursday, a move of more than 10 basis points in less than a day. It was at 1.72% on Friday afternoon.

“The bond movement has been huge and it’s starting to scare people,” Schumacher said.

“There’s been an outstanding question for a while: to what extent can some of the higher octane stocks increase performance?” he asked. “There’s no magic number, but as we talk, the 10 years increase by 80 basis points this year. It’s amazing.”

Powell testified Tuesday and Wednesday before congressional committees along with Treasury Secretary Janet Yellen on Covid’s relief efforts and the economy.

He also talks about central bank innovation at a Bank for International Settlements event Monday morning.

This week, other central bank speakers include Fed Vice President Richard Clarida, Vice President Randal Quarles, Fed Governor Lael Brainard, and New York Fed Chairman John Williams.

There is also some key data.

Major releases include Friday’s consumption and personal spending data, which includes the PCE deflator, the Fed’s preferred measure of inflation. PCE core inflation was operating at an annual rate of 1.5% in January.

Last week, the Federal Reserve did not take any action at its two-day meeting, but presented new economic projections, including the forecast of 6.5% of gross domestic product this year. The central bank’s forecast now shows that PCE inflation will reach 2.4% this year, but will fall to 2% next year.

Most Fed officials did not see interest rate hikes until 2023.

Powell reiterated that the Fed only sees a temporary rise in inflation this year due to the base effects on last year’s numbers when prices fell.

The central bank will set an average inflation range of around 2%, so that number could exceed this threshold for some time. It’s a change in the Fed’s core rules, which makes the bond market nervous.

Normally, the Fed would raise interest rates if inflation rose to avoid an overheating economy and avoid an intense cycle.

“For the bond market and the Fed, there’s a communications issue and a consensus issue. There can be no tension,” said Diane Swonk, chief economist at Grant Thornton.

“They will try to clarify the Fed’s message, but without a consensus on what those figures and railings mean, it will be difficult,” he said. “They will explain themselves as economists and speak a language different from what the bond market speaks.”

Leo Grohowski, investment director at BNY Mellon Wealth Management, expects the bond market to be more volatile than equities and inflation would be problematic for both.

At some point, he expects that there may be a 10% correction in the stock market and that inflation or a sharp move in bond yields could be a trigger.

“The market is trying to make sense of what might be perceived as a disconnect, between its economic projections and the Fed’s dual mandate of unemployment and inflation,” Grohowski said.

“Still, they are committed to keeping short rates on hold until the end of 2023,” he said. “With that the market is struggling. I think I’m worried about hearing words like ‘excess.'”

Grohowski hopes to continue what he calls the “big rotation” of technology and cyclical growth stocks and their value. Growth and technology have been more sensitive to rising rates and the Nasdaq has corrected more than 10%.

“I think we’re in the sixth or seventh inning of a nine-inning game. It’s not over, but I think we’ve seen the lion’s share of the big rotation out of value growth,” Grohowski said. He said that this view depends on the ten years not going up well above 1.75%.

Grohowski is concerned about the Fed’s willingness to let inflation outperform because inflation is negative for stocks.

Supply chain issues are a concern. He noted Nike’s comments on Thursday that its sales were affected by port congestion and also by the shortage of semiconductors, which affects car production.

“Inflation expectations are problematic for P / E [price-earnings] relationships, “Grohowski said.” [stock] the market is trading at 22 times our estimated profit this year. “

He said the market is struggling to reconcile the lack of projected interest rate hikes and the strength of the Fed’s economic forecast.

“If you ask me why I lose sleep? … It’s too good. Too good is being too accommodating,” Grohowski said.

Schumacher said there is a chance the bond market could stabilize in the coming weeks, even if yields rise.

He said corporate pension funds appear to be reallocating capital to bonds before the end of the quarter on March 31, and that could be supportive. In addition, as the Japanese fiscal year is set to begin, there could also be new purchases in U.S. treasuries because, depending on the currency, U.S. debt looks very cheap, Schumacher said.

Next week he is also looking at Treasury auctions.

The Treasury on Tuesday auctioned $ 60 million notes; On Wednesday, $ 61 billion in five-year tickets and $ 62 billion in 7 years on Thursday.

In particular, Schumacher is watching the seven-year auction, which attracted a small demand last month.

Monday

Earnings: Tencent Music Entertainment

9:00 am Fed Chairman Jerome Powell at the Bank for International Settlement Summit

10:00 am Sales of existing homes

10:00 h Quarterly financial report

1 p.m., San Francisco Fed Chair Mary Daly

1:30 pm Vice President of the Fed, Randal Quarles

19:15 to Fed Governor Michelle Bowman

Tuesday

Earnings: Adobe, IHS Markit, DouYu, GameStop, Steelcase

8:30 am Current account

9:00 am, Fed Chairman of St. Louis, James Bullard

10:00 am Sale of new homes

12:00 PM Fed Chair Powell Secretary of the Treasury Janet Yellen on the House Financial Services Committee

1:00 pm Treasury Auctions $ 60 billion in two years

1:25 p.m. Fed Chairman Lael Brainard

1:45 p.m. New York Fed Chairman John Williams

3:45 pm Fed Governor Brainard

4.20 pm Bullard of the Fed of Sant Lluís

Wednesday

Earnings: General Mills, Shoe Carnival, KB Home, HR, Tencent, Embraer, Winnebago

8:30 am Durable products

9:45 am Manufacturing PMI

9:45 h PMI of services

10 a.m. Fed Chairman Powell Treasury Secretary Yellen on Senate Banking Committee

1:00 pm Treasury auctions, five-year notes for $ 61 billion

1:35 p.m. Williams of the New York Fed

15:00 San Francisco Fed Daly

7pm Chicago Fed Chairman Charles Evans

Thursday

Earnings: Restaurants in Darden

5:30 am Williams of the New York Fed

8:30 h Initial claims

8:30 h Q4 third reading of GDP

10:10 a.m. Vice President of the Fed, Richard Clarida

10:30 a.m. Williams of the New York Fed

1:00 pm Treasury Auctions $ 62 billion banknotes at 7 years

1:00 pm Evans of the Chicago Fed

7:00 pm Daly of the San Francisco Fed

Friday

8:30 am Personal income / expenses

8:30 h Advanced economic indicators

10:00 h Consumer sentiment