Last Friday’s much-awaited Jackson Hole symposium featuring Fed Chair Jerome Powell helped to clarify the central bank’s intentions: if the employment situation continues to improve, the Fed will begin to taper asset purchases before year-end. This was the timeline intimated by the Fed for months and shouldn’t be a surprise to anyone paying attention.
Risk assets including the stock market and crypto surged in the immediate response to Powell’s language. Since then, the reaction’s been more muted. Small-cap stocks gave some of that rally back on Monday as investors piled into growth tech. On Tuesday, that leadership flip-flopped again. In cryptoland, bitcoin’s initial enthusiasm was short-lived and is now back below 48,000.
And then there’s the Treasury market. Bond yields declined around Powell’s statement, then leveled off on Monday and edged higher late Tuesday.
This is where investors’ focus should be. We have no better answer today than we did a week ago to the most important mystery of financial markets this summer: why did the Treasury yield curve collapse?
If you think you know the answer, stop. You don’t.
There are plenty of explanations, many of which could work in tandem with one another, but they all ultimately fall into one of two categories. Category A) they are a function of natural, innocuous forces that are more powerful than the ups and downs of growth, or B) lower yields do in fact reflect near-term economic risk.
Category A. These innocuous forces could be long-term interest rates that are held down purposely by the Fed, a demographic drag on interest rates due to an undersupply of safe assets that are in high demand by an aging population, or – in the most recent explanation offered by the Fed – income inequality that’s the cause, not effect, of low rates.
To me, this category is overwhelmingly unsatisfactory. Big-picture explanations like demographics and lack of alternatives are fairly constant forces that do not ebb and flow on a week-to-week basis, and therefore do little to explain extreme moves that happen in short periods of time. As far as the Fed’s intention for long-term rates, it’s pretty backward to argue yields are falling because the Fed is dovish during a period in which the Fed’s gotten incrementally more hawkish.
So let’s focus on Category B. The debate here is over the main economic concern that could be driving investors to Treasuries for safety. Is it just simply the COVID wave pressuring the economy? Or is the stimulus-driven consumer strength of the past year fading as inflation takes hold? Is the market concerned the Fed will tighten things too quickly?
The yield curve’s main nosedive happened in the wake of the June FOMC Minutes, when Fed members hastened the timeline for rate hikes. So one would think that a reversal of that hawkish tone would allow the curve to widen back out. But it’s not really happening. The 10-2 spread is wider than it was a few weeks ago but is flatter since Powell’s speech. The 30-5 spread opened up some but just made a new 52-week low on Thursday.
So was Powell really that dovish after all? If his speech meaningfully shifted policy expectations on the margin, there’s little sign of it yet. In that regard, investors should also pay attention to bitcoin. No asset has a history of responding to a stimulative policy like bitcoin – if Powell were truly incrementally dovish in his message last week, bitcoin would be surging. Instead, it’s actually struggling to hold support at 46,000.
Powell certainly sounds like a guy who’s going to be patient. Investors may want to act the same way. There’s no reason to think right now that the strike on the proverbial “Fed put” supporting markets is any higher than it was a week ago.