To let some hot air out of the markets? As long as it’s not “messy”.
By Wolf Richter for WOLF STREET.
It seems rare that a Treasury secretary and a Fed chairman coordinate their comments on rising long-term yields. Treasury Secretary Janet Yellen, in an interview with PBS NewsHour on Friday echoed what Fed Chairman Jerome Powell said in an interview with the Wall Street Journal on Thursday.
When asked about the rise in long-term yields that Wall Street crybabies so worried about Yellen, Yellen said in her low-key way: “Long-term interest rates have gone up a bit, but I mainly think the Market players see a stronger recovery because we’ve been successful in getting people vaccinated and putting in place a strong tax program that will get people back to work. “
“Are you not concerned about rising interest rates?” he was then asked.
“I think they’re a sign that the economy is getting back on track, and market players are seeing it, and they’re expecting a stronger economy,” Yellen said. “And instead of inflation staying below desirable levels for years to come, they’re starting to see inflation return to a normal range of around 2%.” And inflation may rise more than that, but it will be transient, she said.
So, on Friday, the 10-year Treasury yield fell to 1.57%, still ridiculously low given the inflation outlook, and given the Fed’s insistence on letting inflation exceed. 2% – as measured by the “core PCE”, inflation measures which almost always produce the lowest inflation values in the United States. But this 1.57% was nevertheless the highest since February 14, 2020:
The spread between the 2-year Treasury yield (0.14%) and the 10-year yield (1.57%) widened to 1.43 percentage point. According to this measure, the yield curve is the steepest since November 2015:
This rise in the 10-year yield has sparked a demand among Wall Street crybabies that the Fed do something to bring them down. They have already described the remedies, including another “Operation Twist,” in which the Fed sells short-term Treasury securities and buys long-dated Treasury securities. These concentrated purchases of long-term Treasuries would raise their prices and thus lower their yields.
Wall Street crybabies are clamoring for this because massive, highly leveraged bets on Treasury securities generate massive losses.
Even mundane, conservative-sounding, long-term Treasury bond funds are suffering mounting losses. Since the low point of the 10-year yield last August, the share price of the iShares 20 Plus Year Treasury Bond ETF [TLT] fell 19%.
And the 10-year yield is still just 1.57%. In November 2018, it was more than double and reached 3.24%. In April 2010, there was a day when the 10-year yield went above 4%. Now was the time! All we’re talking about now is a tiny miniscule 1.57%, and the crybabies are out in force to get the Fed to write off those pesky returns that have gone awry.
The Fed responded with a unified voice to indicate that rising yields are a sign of strength, and as long as it is a sign of increasing strength and not of tightening financial conditions, it will let them rise. .
It’s funny that Yellen has now pampered Powell and sings from the same hymn sheet with Powell to fight the Wall Street crybabies.
His expression of comfort with higher long-term yields and rising inflation expectations came the day after Powell laid out the Fed’s position in an interview with the Wall Street Journal.
The Fed expects inflation to rise for two reasons, Powell said in the interview. “The base effect”, the inflation index having fallen in the spring of last year; and a “spending surge” that could lead to “bottlenecks” as the economy reopens, which could create “some upward pressure on prices”. But the Fed will wipe out “one-off effects” and any “transitory increases in inflation,” and it will be “patient” with rate hikes, he said.
To deal with rising bond yields, he said, “I would be concerned about the disorderly conditions in the markets or the continued tightening of financial conditions which threaten the achievement of our goals.” The expression “disorderly conditions” came up several times.
The speed of the rise in long-term yields “was something noticeable and caught my eye,” Powell said. “But again, it’s a wide range of financial terms that we’re looking at, and that’s really the key; it’s a lot of things. We want to see and we would be concerned if we didn’t see “orderly conditions” in the markets, and we don’t want to see persistent tightening in broader financial conditions. This is really the test, ”he said.
So as long as conditions aren’t “messy,” as long as the 10-year yield zigzags in an “orderly” fashion, and doesn’t go too far, and as long as a “wide range of financial conditions” remains accommodating – they are still “very accommodating,” he said – the Fed would let long-term yields do what they could and see them as a sign of economic strength and welcome rising inflation expectations.
On the other hand, if the markets become messy again, as they were in March, “the Committee is ready to use the tools at its disposal to help achieve its objectives,” he said.
He declined to determine at what level of the 10-year yield the Fed would get nervous and start digging through its toolbox. But apparently that point is not yet imminent.
The effect is that higher long-term yields leave some of the hot air out of the markets. And the Fed can encourage it, as long as it is “orderly”.
The bond market has been hammering for months, with large losses scattered across Treasuries with long maturities and high quality corporate bonds. The housing market will eventually respond to rising mortgage rates, and mortgage rates began to rise in early January.
But junk-bond yields barely rose from record lows. Demand for these instruments remains searing, against a background of record emissions so far this year. This enthusiasm for junk bonds – which allows all kinds of shaky companies to finance their cash consumption – is a sign of “very accommodating financial conditions”.
When the average BB yield doubles to 7% and the average CCC yield doubles to 15% (my cheat sheet for bond credit ratings), financial conditions tighten, funding the machines to burn money. money becomes more and more difficult and expensive, and the Fed would get nervous. But this is not yet the case.
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