…. who makes some interesting cases on all this,based on bond market action.
my weekly fix, and he is very hard to summarise came in the inbox today, goes along these lines:
[Looking at] the yield differential between 5-year US Treasuries and 30-year US Treasuries.
That’s what you call a flattening of the yield curve.
As you well know the trade that was all the rage, particularly amongst the hedge funds, was the ‘curve steepener’ and one of the most popular expressions of this was to buy 5-year notes and sell 30-year bonds.
You will also recall that I was an advocate of the ‘curve steepener’ trade too, after the vaccine news in early November 2020.
The basic premise was that the Fed was wrong about inflation and that monetary policy was far too accommodative.
The hedge funds were right. Inflation has far exceeded the Fed and the market’s forecasts.
And now that the U.S central bank has revised up its inflation forecast and brought forward the ‘tapering’ process they are acknowledging that they need to change tack.
So far so good.
Think of it this way.
If the Fed had continued to ignore the fact that inflation was much higher than they had anticipated, they would run the risk of losing credibility.
Furthermore, if inflation had continued to stay stubbornly high then they may have to slam the monetary breaks on and risk a financial market crash.
Better to act now, rather than having to act very aggressively at a later date.
Yes, I know this somewhat contradicts their new policy of being reactive rather than pre-emptive.
The problem is when the smartest Wizards on Wall Street are all saying publicly that the Fed is making a colossal policy mistake it’s a bit hard for Powell to ignore them.
It appears that the majority of FOMC members agree with the Wizards and not Powell.
Let’s agree it gets a bit uncomfortable listening to the ‘inflation, what inflation story’ when there is a BIG 5.0% CPI number sitting in front of you on your Bloomberg screen.
The interesting bit of this inflationary riddle is of course the transitory piece.
The great majority of economists, if you look at the Bloomberg consensus forecast for Core PCE inflation at the end of 2023, believe that inflation will return to 2.1%.
Remember, however, that none of them anticipated inflation getting anywhere near 5.0% by this May.
Perhaps, therefore, we can think of the Fed’s rather interesting recent change in approach as bringing back a more judicious risk management approach.
Remembering also that they are still buying an astonishing $120 billion of securities every month, notwithstanding the highest inflation and strongest economic growth many of us have seen.
The first significant change will be a reduction in the purchases of mortgage backed securities (MBS).
The Federal Reserve can no longer justify the purchase of $120 billion (80 billion USTs and 40 billion MBS) worth of securities every month.
You have all seen the U.S housing market and would surely agree that $40 billion of MBS every month is, to put it politely, simply ridiculous.”
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