With a wink and a nod, Federal Reserve Chairman Jerome Powell signaled to markets that a gradual reduction in the size of the Fed’s QE asset purchases could begin in November assuming the September jobs data is “decent.” Moreover, the Chair said a taper that “concludes around the middle of next year is likely to be appropriate.” A little quick, speculative math tells us that this could mean monthly reductions of $10bn in Treasuries and $5bn in MBS which allows for the complete elimination of the $120bn/month purchase program by that time. The willingness to telegraph an endpoint in advance is quite different from the 2013-14 experience when it was a less certain month-by-month process. Revised FOMC economic and interest rate projections were also released, showing a median GDP growth estimate for this year that was marked down to 5.9% from 7%, but for ’22 was bumped up to 3.8% from 3.3%. Core inflation is estimated to come in at 3.7% this year, but falling to 2.2% over the next two years. The “dot plot” projections of the trajectory for Fed Funds showed that nine of the eighteen officials expected one or more rate hikes next year, up from seven who thought so in July.
Initial market reaction to all of this was remarkably muted, but on reflection and absorption of the ripple effects, the bond market sold off sharply and pushed the 10yr T-Note yield up to 1.42%, the highest in over two months. The yield curve flattened initially, then steepened out to the widest since Independence Day as the difference between a 2yr versus 10yr Treasury yield now sits at 118bps. For its part, the stock market traded in a scatterbrained pattern (not a technical term) partly because of credit contagion fears from Evergrande, the Chinese property giant that’s facing a serious debt crisis and could presage a broader economic slowdown in China, where the real estate sector makes up about 30 per cent of GDP. If that wasn’t enough to cause tremors, we’re also having to witness the uniquely American ritual surrounding whether or not to pay our debts, when politicians are asked to raise the “debt limit” after they’ve already made irreversible commitments. Ugh. It’s no wonder the Dow traded in a 1200-point range Wednesday and Thursday.
On the data ledger this week, Housing Starts, Building Permits, Leading Indicators and New Home Sales all came in better than expected. While Existing Home Sales were weaker than expected and jobless claims jumped at bit. On balance, the data was neither good nor bad. Goldilocks would approve. Next week, look for fresh news on consumer sentiment and second quarter GDP data… and hopefully the US will decide to pay its bills.
US 10-Year T-Note Yield: Sept 2020 – Today
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