Stocks Matter Most Now, Even for Bond Traders

(Bloomberg Opinion) -- Federal Reserve Chairman Jerome Powell finally decided that the stock market’s tantrum over the past month was too noisy to ignore. 

Traders bemoaned the fact that Powell considered the central bank’s balance-sheet runoff to be on “automatic pilot.” So he softened his tone on Friday during a panel at an American Economic Association meeting in Atlanta, saying policy makers “wouldn’t hesitate to make a change” if necessary. Investors were unhappy that Powell shrugged off swings in the stock market as “a little bit of volatility” that shouldn’t do much harm to the economy. So he assured them that the Fed is listening carefully to the market’s concerns about downside risks. He and his predecessor, Janet Yellen, both reminded listeners about 2016, when the median projection among officials was for four rate increases, yet they only went through with one.

All of this sounds dovish and explains why the S&P 500 Index rose as much as 3 percent as Powell, Yellen and Ben S. Bernanke spoke and extended gains afterward. But that doesn’t quite match up with the move in the U.S. Treasury market. Two-year yields soared as much as 12 basis points, the largest intraday increase since November 2015. Ten-year yields rose 11 basis points. Usually, such a move would happen only if expectations for further interest-rate hikes increased drastically. But fed funds futures indicate that bond traders expect the Fed to stand pat, at best, in 2019 and cut rates as soon as mid-2020.

Stocks Matter Most Now, Even for Bond Traders

Now, Treasuries had almost certainly rallied too much to start the New Year — relative strength index analysis shows that two-year notes were at the most “overbought” level since early 2008, while 10-year and 30-year debt veered into similar territory. But looking at the movement across asset classes, it’s becoming clear that everything revolves around the stock market at this point. Just as Powell succumbed to acknowledging its importance, bond traders, too, are left taking their cues from their counterparts in equities.

In some ways, this is a good thing. A few months ago, when Treasury yields increased and stock markets declined, many investors fretted about a breakdown in the traditional correlations between the two assets. Bonds have rallied lately as equities have declined, and vice versa.

The question is, what happens now? If Friday was when the “Powell put” — a term he surely hates — took full effect, then the chairman has put the Fed in a bind. The bond market still isn’t pricing in anything remotely close to another full interest-rate increase in 2019, even after a blockbuster employment report that showed U.S. employers added 312,000 workers in December, exceeding all forecasts. If economic data remain solid, can traders start pricing in a rate hike in 2019 without spooking stocks? And can Fed speakers start talking up another move instead of repeating the soothing message that they’re in no hurry and are content with pausing?

It’s often said that bonds are smarter than stocks, so how Treasury yields move in the coming week, particularly around the Jan. 9 release of the Federal Open Market Committee’s minutes of its December meeting, may provide further clues to how all these competing interests will work themselves out. To me, Powell’s message on Friday wasn’t too different from his press conference last month, except that he reworked his language to specifically appease the stock market.

That shift, though, is enough to give the stock market the upper hand, both over the Fed and Treasuries. Until further notice, swings in equity indexes should be the most important cue for bond traders.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

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