Before the Bell: The Fed vs. Bond Markets vs. Inflation

Treasuries sold off on Thursday ahead of the announcement of a hefty fiscal stimulus package. Yields jumped a handful of basis points, with the 30-year finishing at 1.869% and the 10-year at 1.127%. The bond market ignored Fed Chair Powell’s comments that any removal of stimulus is well in the future and that there will be plenty of warning before such actions. Stocks closed slightly lower, having erased the day’s gains into the close, leaving the S&P 500 down -0.38%.

The markets have largely priced in stimulus, but there could be some gyrations on some of the finer details. Additionally, it’s the start of earnings season with several big banks reporting. Much will depend on guidance, which is expected to be rather optimistic given vaccine developments.

We believe that the Federal Reserve will continue to be the primary driver for the markets and the US economy.  Recent statements by the Fed indicate rate hikes are not being considered anytime soon. However, bond yields have shot up recently which would indicate otherwise.

Jermone Powell discussed the Fed’s policy framework and its response to the coronavirus in a webcast with Princeton University this week. He stated that there is an appropriate time for interest-rate increases to starve off higher inflation, but it would not happen anytime soon. Powell also emphasized that while the economic recovery has momentum, the Federal Reserve would not cut back on its bond-buying program.

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“Now is not the time to be talking about exit,” Powell stated, adding that a lesson of the Covid financial crisis is to be careful “not to exit too early.”

Frankly, this has put market analysts confused because there are strong signs of inflation and the Fed is not likely to raise rates. We are telling readers to be careful about bonds and bond funds because rising interest rates could crush them.  Historically, we would bet on the Fed not moving rates which will force the market to adjust.

It’s a hefty economic calendar today too, though we suspect the reports will be viewed as old 2020 news. December retail sales highlight, seen declining -0.2% after November’s -1.1% slide. Excluding autos, sales are expected to fall -0.4% versus the prior -0.9% tumble.

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December PPI is penciled in rising 0.2% from 0.1% previously for the headline, and edge up 0.1% on an ex-food and energy basis, as it did in November. December industrial production should rise 0.6% versus 0.4%, while capacity utilization is expected to increase to 73.8% from 73.3%.

November business inventories are expected to rise by 0.5% versus the 0.7% increase in October. The January Empire State index likely improved to 6.0 from 4.9.

The preliminary University of Michigan consumer sentiment index is forecast to rise to 81.0 from 80.7. Earnings season kicks off, with JP Morgan Chase, Wells Fargo, Citigroup, and PNC all reporting.

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