Federal Reserve Jerome Powell testified at a hearing on the Senate Banking Committee on ‘The Quarterly CARES Act Report to Congress’ at Capitol Hill in Washington, USA, December 1, 2020.
Susan Walsh | Reuters
Rising yields and associated inflation fears add some drama to Federal Reserve Chairman Jerome Powell this week before Congress.
The chairman of the central bank will address the Senate and House panels after consecutive days as part of the mandate of biannual updates on monetary policy.
Ordinary routine issues, recent turmoil in the financial market and concerns about how the Fed may react cause investors to pay a little more attention than usual on Tuesday and Wednesday.
“This is one of the more interesting episodes in which a Fed chairman had to testify,” said Nathan Sheets, chief economist at PGIM Fixed Income. “Sometimes we say, ‘Listen, no news.’ “It’s going to be news. He’s really caught between a rock and a difficult place.”
The attention of the market has recently been an increase in government bond yields, especially further off the curve.
While the 2-year is unchanged for 2021, the five-year rose by a quarter percentage point from Friday’s market, while the 10-year note increased its yield by 41 basis points to 1.34%, an area where it had not been there since about the same time in 2020, before the worst pandemic struck.
The thirty-year bond yield has risen even more, jumping almost half a point this year to 2.14%.
Powell’s dilemma is this: Rising bond yields may be an indication of the reflection of the economy that has pushed the Fed and therefore it is higher for good reasons. However, if the trend gets out of control, the Fed may need to sharpen policy faster than the market expects, and this will compensate for the good that comes with yields.
What complicates the matter is that markets may not like it if Powell is too complacent.
“If this evidence was behind closed doors, I think Jay Powell would be very pleased with what he sees in the economy and the markets,” Sheets said, nicknamed the Fed chair. ‘But given the fact that it’s public, he has to be careful. If he is too stupid about the rise in rates, the markets will see it as an important green light to raise rates. ‘
“The Fed is comfortable with an organic rise in rates that is reflected in the view of growth and inflation,” he added. “But I think the Fed also wants to note that it is not creating and strengthening a self-sustaining dynamic that raises rates for other reasons.”
These ‘other reasons’ are mainly the fear that the economy could overheat.
Stimulus and more stimulus
The Fed has pursued a historic, loose policy over the past year, dropping its standard lending rate to near zero and buying at least $ 120 billion in bonds each month. It is, moreover, a series of loan and liquidity programs that have since fallen into disrepair, implemented in the early days of the Covid-19 crisis.
With that, Congress has received more than $ 3 billion in fiscal stimulus and could end up approving $ 1.9 to $ 1.9 billion more.
All that has happened in the midst of an economy that, apart from a still worrying job problem, is mainly buzzing in the service sector. Wall Street expects growth expectations in the first quarter and market-based indicators of inflation rise.
That’s why Powell’s cord wire will be all the more compelling this week.
“The market mood has changed,” Mohamed El-Erian, chief economic adviser at Allianz, said on CNBC’s “Squawk Box” on Monday. It is no longer whether the returns go higher, that is when the move is too big. This is what the market is trying to figure out. ‘
Investors are particularly concerned that all the stimulus is not going overboard and threaten to destabilize the economy in the long run.
‘I can predict that the yellow lights are flashing all over the Fed because of the [yields] “moving and weakening the yield curve, and the Fed can do more to try to control yields,” El-Erian said.
Fed officials largely rejected the so-called yield curve control to use the purchasing power of the bonds to control rates between different fixed maturities.
But the market could force the Fed’s hand, and Powell will likely be asked where he stands on what tools the Fed has to calm market issues. He has repeatedly stressed that the Fed has the weapons to control inflation, but its use has a price. Markets used to be weak and companies accustomed to cheap borrowing costs could be hit by an unexpected Fed move.
Evidence of how clearly the market is monitoring the issue came on Monday morning when Christine Lagarde, president of the European Central Bank, said she was closely monitoring the evolution of nominal bonds in the longer term. Her words were enough to calm a turbulent market and to be an opening loss on Wall Street, a mixed market with the Dow in the early afternoon trading. Treasury yields were mostly low on the day.
Tom Lee, managing partner and head of research at Fundstrat Global Advisors, noted that his clients have already expressed some concern over this week. Part of this reflects the fact that bond yields have risen steadily and that investors in equities are nervous about the bond market. can reach a kind of ‘breaking point’ during Powell’s testimony.
Powell will speak to the Senate Finance Committee on Tuesday when he speaks to the House Financial Services Committee on Wednesday.