Jay Powell, the Federal Reserve chair, triggered a sudden sell-off in long-term US Treasury debt and equities after he vowed to keep monetary policy steady even as the economy improves and inflation begins to rise.
Speaking on Thursday afternoon, Powell said the central bank expected to be “patient” in withdrawing support for the recovery, given that the labour market remained far from the central bank’s goal of full employment and had made little progress in recent months.
Powell’s comments failed to alleviate fears that the central bank is reacting too slowly to the recent rise in inflation expectations and long-term Treasury yields.
Although the Fed chair suggested central bank officials were closely watching the market movements, he did not signal any looming intervention by the Fed to cap long-term Treasury yields, saying it would take much more to perturb him.
“As it relates to the bond market, I’d be concerned by disorderly conditions in markets or by a persistent tightening in financial conditions broadly that threatens the achievement of our goals,” Powell said.
The US market decline following Powell’s remarks is a possible harbinger of more volatility to come. The Fed’s view that there is a high bar to any tightening of policy is increasingly clashing with investor expectations of a rapidly improving recovery.
“This is all uncharted and hence uncomfortable territory for all of us,” said Tim Duy, a Fed-watcher and economics professor at the University of Oregon, in a note after Powell’s remarks. “Barring a financial accident, the Fed will tend to hold a steady path — emphasising its commitment to low rates until inflation rises sustainably above 2 per cent — as sentiment shifts around it.”
Yields on 10-year Treasuries spiked 0.07 percentage points to 1.55 per cent after Powell’s remarks, reviving a rout in the $21tn market for US government debt. Investors are grappling with the prospect of a stronger-than-expected recovery and higher inflation later this year.
One market measure of inflation expectations, the 5-year break-even rate, hit 2.5 per cent on Wednesday for the first time since 2008. Inflation erodes the value of bonds’ income payments, making them less attractive.
US stocks also sold off sharply after the Fed chair spoke, with the S&P 500 closing down 1.3 per cent. The tech-heavy Nasdaq Composite dropped over 2 per cent, turning negative for the year.
The sharp rise in bond yields has increased pressure on equities in recent weeks since higher interest rates dent the appeal of companies’ future cash flows. This hit has been particularly severe for high-flying technology stocks, which already trade at historically elevated levels compared with their earnings expectations.
Powell did say that if the Fed faced an unhealthy spike in inflation this year, it would be able to handle it. “We have the tools to assure that longer-run inflation expectations are well-anchored at 2 per cent. Not materially above or below. And we’ll use those tools to achieve that,” he said.
Such statements may not be enough to satisfy investors.
“The bond market will feel quite unprotected by what Powell said today from an inflation perspective,” said Padhraic Garvey, global head of debt and rates strategy at ING. “There is plenty of room for yields to move to the upside.”
Given the Fed’s stance and expectations of a robust rebound, Garvey reckoned that 10-year yields could rise to 2 per cent in the third quarter of this year.
“Powell did nothing to suggest he is any more concerned with the recent jump in long-term yields than he was last week when he referred to rising yields as a ‘statement of confidence’ in the US economy,” said Mike Schumacher at Wells Fargo.