Powell’s comments on inflation drive down US stocks, bonds

Jay Powell, the chairman of the Federal Reserve, triggered a sudden sell off of long-term US Treasury debt and stocks after promising to keep monetary policy stable even as the economy improves and inflation begins to rise.

Speaking Thursday afternoon, Powell said the central bank expected to be “patient” in withdrawing support for the recovery, as the labor market remained far from the full employment target of central bank and had made little progress in recent months.

Powell’s comments did not alleviate fears that the central bank was reacting too slowly to the recent rise in inflation expectations and long-term Treasury yields.

Although the Fed chairman suggested central bank officials closely monitor market movements, he did not signal any imminent Fed intervention to cap long-term Treasury yields, saying he does. would take a lot more to disrupt it.

“With regard to the bond market, I would be concerned about disorderly conditions in the markets or a persistent tightening of financial conditions which threatens the achievement of our objectives,” said Powell.

The decline in the US market following Powell’s remarks is a possible harbinger of greater volatility to come. The Fed’s view that there is a high bar to any policy tightening is increasingly at odds with investor expectations of a rapidly improving recovery.

“This is all uncharted territory and therefore uncomfortable for all of us,” said Tim Duy, Fed observer and professor of economics at the University of Oregon, in a note after Powell’s remarks. “Barring a financial crash, the Fed will tend to maintain a stable path – underscoring its commitment to low rates until inflation rises sustainably above 2% – as sentiment moves around of her.

Yields on 10-year Treasuries climbed 0.07 percentage point to 1.55% after Powell’s remarks, reviving a rout in the $ 21 billion US government debt market. Investors are grappling with the prospect of a stronger-than-expected recovery and higher inflation later this year.

A market measure of inflation expectations, the 5-year equilibrium rate, hit 2.5% on Wednesday for the first time since 2008. Inflation is eroding the value of bond income payments, making them less attractive .

US stocks also sold sharply following the Fed Chairman’s speech, with the S&P 500 closing 1.3% lower. The highly technological Nasdaq Composite fell more than 2%, turning negative for the year.

The sharp rise in bond yields has increased the pressure on equities in recent weeks, as rising interest rates hurt the attractiveness of future cash flows for companies. This hit was particularly severe for high-tech tech stocks, which are already trading at historically high levels compared to their earnings expectations.

Powell said if the Fed faced an unhealthy rise in inflation this year, it would be able to handle it. “We have the tools to ensure that long-term inflation expectations are firmly anchored at 2%. Not materially above or below. And we will use these tools to make it happen, ”he said.

Line graph of the equilibrium rate (%) showing that inflation expectations in the United States are pushing up

Such statements may not be sufficient to satisfy investors.

“The bond market will not feel protected by what Powell said today from an inflation perspective,” said Padhraic Garvey, global head of debt and rates strategy at ING. “There is a lot of room for yields to move up.”

Given the Fed’s stance and expectations of a robust rebound, Garvey estimated that 10-year yields could reach 2% in the third quarter of this year.

Powell has done nothing to suggest that he is more concerned about the recent surge in long-term yields than he was last week when he called the surge in yields a ‘statement of confidence’ in the US economy, ”said Mike Schumacher of Wells Fargo. .

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