The monetary markets have been combating the Fed since October of final yr, particularly for the reason that begin of this yr, in two methods. The primary entails bidding-up inventory costs in anticipation of a ‘Fed pivot’, which we now have described as a self-defeating technique. The second entails factoring decrease rates of interest into bond costs, which we thought made sense. What’s the present state of play within the battle between the markets and the Fed?
Simply to recap, we wrote in lots of earlier commentaries that inventory market bulls would get the financial coverage reversal on which they have been betting solely AFTER the plunged to new bear-market lows and the financial information had turn out to be weak sufficient to take away all doubt {that a} recession was underway.
In different phrases, a really weak inventory market was one of many conditions for the coverage reversal. That, in essence, is why bidding-up costs in anticipation of a coverage reversal was/is seen as a self-defeating technique. Additionally price reiterating is that earlier fairness bear markets weren’t shut to finish when the Fed made its first charge reduce. This suggests that if we’re nonetheless months away from the Fed’s first charge reduce, we might be a yr away from the ultimate bear market low.
Concerning the opposite side of the Fed combating, we now have written that rates of interest in all probability would transfer a lot decrease over the course of 2023 resulting from an financial recession, an extension of the downward pattern in inflation expectations, and a collapse within the year-over-year progress charge. This meant that from our perspective, the monetary markets have been proper to be factoring decrease rates of interest into Treasury securities with durations of two years or extra.
Nevertheless, within the sixteenth January 2023 Weekly Replace, we cautioned:
“The current eagerness of merchants to push-up asset costs in anticipation of simpler financial coverage has, sarcastically, prolonged the seemingly period of the Fed’s financial tightening. Due to this fact, whereas the markets in all probability are proper to low cost decrease rates of interest over the approaching yr, ‘combating the Fed’ has created a excessive danger of rates of interest rising over the subsequent 1-3 months.”
Partly resulting from fairness merchants trying to ‘entrance run’ the Fed, the financial tightening has been prolonged, and rates of interest rose markedly from mid-January by way of to the primary half of final week. The and Treasury yields have remained under their October-2022 cycle highs, however the Treasury yield, which had signaled a downward reversal late final yr, made new highs over the previous fortnight.
The next chart reveals the surge within the 2-year Treasury yield from a multi-month low in mid-January to a brand new cycle excessive in the course of the first half of final week. It additionally reveals that there was a pointy decline in the course of the second half of final week. Will the newest downward reversal stick?
UST2Y Every day Chart
We suspect that it’ll. It’s seemingly that 10-year and 30-year Treasury yields have reversed downward after making decrease highs. The two-year Treasury yield has made a sustainable downward reversal from a barely greater excessive for the cycle. That is the case as a result of different markets are signaling the beginning of a shift away from danger.
There’s a superb probability that throughout the subsequent few months, inventory market bulls will get the Fed pivot they’ve been betting on. Nevertheless, they in all probability will get it with the SPX at 3000 or decrease.
