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Komal Sri-Kumar: Why Yields Rose Again, Powell's Cheerleading Stopped Working!

The theme of the last SriKonomics was that equity and fixed income markets were experiencing premature euphoria and that there is a lot of uncertainty ahead on the inflation front. Reality started to unfold this past week that inflation would not come down fast enough to induce the Federal Open Market Committee to cut rates any time soon. The shift in sentiment was best expressed by the yield on two-year Treasurys that reflect market expectations for Federal Reserve policy. The yield rose from 4.84% at the start of trading Monday to close the week at 4.95%.

A major factor behind the rise in yields was the publication on Wednesday of the minutes from the the FOMC meeting held on April 30 and May 1. Just a few days before Chairman Jerome Powell gave his view on May 14 at a banking conference in Amsterdam that "I don't think that it is likely based on the data we have that the next move that we make will be a rate hike," some FOMC members had, in fact, expressed greater concern. They questioned whether Fed policy was tight enough to bring inflation down to the 2% Fed target. According to the minutes, a "few" officials wanted the monthly ceiling for Treasurys being put into the market to be kept at $60 billion, or even increased. The FOMC decision announced May 1, on the other hand, was to lower the ceiling from $60 billion to $25 billion.

Details of the FOMC discussion regarding monetary policy not being sufficiently tight prompted the backup in yields last week despite Powell's attempts to calm markets through his speech in Amsterdam. On the data front, initial jobless claims fell for the second successive week to 215,000 suggesting continued strength in the labor market. Recall that the sharp increase in initial jobless claims to 232,000 in the week ending May 4 had led to the view that the economy was slowing, and had contributed to a rally in equities and Treasurys.

Also adding to investor concerns were statements by Fed officials that inflation was going to come down only slowly (Atlanta Fed President Raphael Bostic) or that more restrictive measures may be necessary (Boston Fed President Susan Collins). These officials had a better understanding than the Fed Chairman that inflation comes down only gradually at the late stages of its journey. And in established fashion for this Federal Reserve, the officials were expressing contradictory views in public, contributing to overall confusion and adding to market volatility.

Minutes of the FOMC decision at the start of the month, continued strength in the labor market, and hawkish views of some Fed officials all led some investors to believe that there will not be a rate cut before September. And since hopes for imminent rate cuts that Powell had fostered were a major factor in the prior rise in valuations, the latest developments turned out to be a damper.

It did not help inflation doves to hear Treasury Secretary Janet Yellen finally admit that high inflation is a "problem to a lot of people." Speaking to the Financial Times on Thursday, Yellen admitted that even strong wage growth had not kept pace with inflation. After she and Powell championed the surge in the fiscal deficit and the doubling of the Fed balance sheet during 2020 - 2022, the Treasury Secretary is now worried about high inflation affecting a significant portion of the US population. She is correct in her diagnosis. The problem is that she is three years too late with her concern!

All of this takes me to my oft stated view: Lack of sufficient progress in inflation will not allow for a rate cut anytime this year unless something within the system "breaks" – in the banking sector or in Commercial Real Estate, for example. Twists and turns in Powell Pivots at his press conferences could further muddy the outlook.

Dr. Komal Sri-Kumar


Sri-Kumar Global Strategies, Inc.

Santa Monica, California

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Posted: May 25, 2024 Saturday 09:01 AM