Bonds have been consolidating aggressively for an entire month. 10yr yields have been perfectly contained between 0.63 and 0.73 with one brief occasion following Fed Chair Powell's Jackson Hole speech. Actually, the volatility on that day had more to do with the release of the Fed's updated inflation framework, and it was this, more than anything, that set the stage for the consolidation leading into the current week.
The Fed is obviously feeling a few things:
- They feel like they would have done things differently in the past few years if they knew then what they know now. Specifically, they have expressed some remorse about raising rates too quickly and/or too soon. Hindsight is definitely 20/20 in that regard considering popular opinion was that the Fed had waited too long to start hiking rates. Incidentally, the long wait was part of the problem. They should have started and stopped hiking about a year earlier than they did.
- They feel concerned about the fate of the economy after the initial covid rebound plays out (and after the stimulus effect runs out and/or moderates to a less accommodative position).
- They feel like inflation is no longer playing by the previously understood rules. Specifically, they can be more accommodative than they were without risking hyperinflation.
- They feel like doing as much as they can do to help address the opportunity gap seen growing wider due to covid, and that being overly-accommodative will help more businesses succeed and thrive--businesses that employ the workers who the Fed sees getting the short end of the covid stick.
The net effect of these feelings is a significantly more accommodative Fed, both in terms of how long interest rates will remain at lows and how much of the bond market they'll be buying. The framework change paves the way for the accommodative message this week. We don't know exactly what that will look like, but several leading theories include:
- Forward guidance shift (i.e. more strongly worded guidance about how long rates will remain near zero, and how high the bar is for that to change. This shift would help the middle of the curve most--i.e. 5-7yr bonds--as 2-3yr bonds are already near zero.)
- WAM Change (i.e. a change to the weighted average maturity of the Fed's bond portfolio. This is a bit esoteric, but the gist is that the Fed can effectively provide accommodation by buying longer maturity bonds. This shift would help longer-dated debt most--i.e. 10yr Treasuries and MBS
- A recharacterization and/or reinforcement of existing bond buying programs (i.e. the Fed may officially label its bond buying efforts as "accommodative" as opposed to being driven by the need for liquidity and smooth market function. They could take this a step further by putting some sort of timeline on bond buying or in the most extreme case, by increasing the purchase amounts. This is good for longer-dated debt as well).
- Dot Plot Shift (i.e. the Fed's recent communications suggest we should be prepared to see an extraordinarily dovish release of their economic projections--aka the "dot plot." To whatever extent the Fed says it sees 0-0.25% rates and low growth for longer, market participants will assume their accommodation will remain intact that much longer--also good for longer-dated debt).
But alas, today is Monday and the Fed won't be with us until Wednesday at 2pm. In the meantime, there's no significant economic data today and light data tomorrow. The week's only major release--Retail Sales--will hit on Wednesday morning, but it's hard to imagine traders would want to chase that data very far outside the lines when the market has so intently been consolidating for Fed day.