Baker Market Update – wk211126

Wow. The week of Thanksgiving is normally sedate for financial markets, and traditionally the day after Thanksgiving is the single lowest volume day of the year. This year is quite different. In the last five active sessions, bond yields have ranged from an intraday low of 1.50% to a high 1.69% and now sit at 1.49%. There were some noteworthy news items this week to be sure, but a sudden and convulsive change in sentiment was driven by rising COVID caseloads and a new strain of the virus which has frightened markets and raised questions about the path forward for global economic conditions.

The data stream was light this week. Existing home sales rose a touch higher than expected, and initial jobless claims continued to improve. More interesting was the November FOMC minutes which revealed that policymakers generally still believe inflation is likely to be transitory but now expect the transition to take longer than previously expected. An understatement I’d say. Regarding the taper announcement, the minutes said “some participants suggested that reducing the pace of net asset purchases by more than $15 billion each month could be warranted.” This would allow them to move faster on the funds rate in light of stubbornly high inflation. Market expectations of a more aggressive Fed were immediately adjusted. Notably, the yield curve (10yr minus 2yr) has flattened by 30bps in less than two months.

Also, President Biden announced this week he would nominate Jerome Powell for a second term as Fed Chair which was not unexpected. He simultaneously announced the appointment of Lael Brainard as Vice Chair of the Board. Powell and Brainard hold similar views on the conduct of monetary policy, but Brainard is seen as having a greater inclination toward active regulation. There remain three vacant seats on the board and we may get nominations in the coming month.

The thing that’s really moving markets this week, however, is the realization that COVID is again rising as a threat, and a virulent new strain is suddenly front and center. We’ve learned not to take this lightly. This new strain has reportedly already popped up in Hong Kong and Israel, and it’s too early to know whether and to what degree current vaccines provide protection. The Europeans among others are already re-imposing lockdowns. It’s important to remember that it is the restrictions imposed in response to the virus rather than the virus itself that causes damage to the economy and financial markets. Time will tell, but for now the US Treasury market is seeing a powerful rally as scared money flows to the safe haven.

US Treasury Yield Curve Slope: 2yr vs 10Yr

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