There is a highly reliable track record of the bond market moving quickly to get in position for the Fed’s expected course of action. When those expectations shift gradually over time, or when there is balance in the debate about the direction of the policy shift, bonds refrain from big, scary spikes. 2022 has been characterized by the opposite scenario where the Fed has repeatedly nudged market expectations, but by accelerating the actual removal of accommodation and by doubling down on hawkish forward guidance (the stuff the Fed says it’s going to do in the future).
One of the biggest problems at the moment is that the market learned to expect the Fed to walk back its hawkish messaging after big rate spikes. But this time around, the Fed has been stone silent on that front. That phenomenon, more than anything else, is responsible for the move from 2.25 to 2.65% in 10yr yields over the past 3 weeks. There are two key instances that have serves as “bumps” in this regard in the past 3 weeks. The first was when Powell said nothing to push back on the early March rate spike during his 3/21 speech. The second was when Brainard struck a hawkish tone yesterday despite being a well-known Fed dove.
The point is that the Brainard and Powell of the past would have said something to try to modulate the runaway rate spike. The Brainard and Powell of 2022 already regret not being more hawkish in 2021 and refuse to get caught erring on the side of dovishness with inflation metrics at generational highs. The comments from both Fed speakers have been on-message. It’s the financial market that’s struggling to come to terms with the new rate reality we’ve been warning you about since the first week of January.
NOTE: the Powell/Brainard spikes are NOT driven by inflation–at least not exclusively. Inflation played no part in Powell’s spike and only a limited role in Brainard. We can see this in the following chart that shows cash yields (blue line in top portion) and inflation adjusted yields (green line). When the green line is moving higher, rates are rising for reasons other than inflation. Also notice that rates were flat for days or even weeks before these two key Fed voices abstained from offering the solace the market expected (flat red lines showing unchanged 10yr yields).
If it’s not inflation, then what is it? Part of the answer is Fed rate hike expectations. Powell’s speech had a much bigger impact in that regard. It created a clear departure from what had been a very orderly move in the preceding weeks.
It’s also about balance sheet normalization. And this is why we don’t see Brainard’s speech show up with a big spike in Fed Funds Rate expectations in the 2nd chart. By echoing her colleagues in calling for bigger/faster adjustments to the Fed’s balance sheet, Brainard was confirming that the Fed would be decreasing its bond buying every bit as fast as feared AND that even the most rate-friendly Fed members agreed that needed to happen regardless of the damage already done. In other words, Brainard made these comments in a world where 10yr yields had already hit 2.5% and where mortgage rates had already risen more than 200bps at one of the fastest paces in history.
Let’s bring it home with a hastily chosen analogy. The market is like a baby bird who was just pushed out of the nest, looking up at its parents, waiting for help to come. But the parents are just shaking their little birdie heads saying “nope… you’re on your own.” On the way to the ground, the market just got a memo that it will receive another message from its parents today at 2pm–one that will likely reiterate the same message. It’s only natural to brace for impact.