Here's a sneak peek of the key takeaways:
- Fed Chairman Jerome Powell faces a difficult problem in the bond market, with bond rates rising sharply since early July, but he stressed that the economy is strong and that monetary policy tightening may need to continue to avoid inflation risks.
- Powell sees the recent bond problem as a sign of tightening credit conditions, rather than an obvious tightening of monetary policy, amounting to an increase in the federal funds rate of at least 25 basis points.
- While the U.S. economic data is mixed, and the labor market remains strong, rising bond rates could have a negative impact on equities and the outlook needs to be reassessed.
Fed Chairman Jerome Powell now faces a worrying problem: big problems in the bond market. Since the beginning of July, bond rates have risen sharply, from about 4.00% to almost 5.00% today. This may raise some concerns, but Powell did not show obvious concern in recent interviews. Instead, he believes the economy remains strong and may need to continue tightening monetary policy. "We are looking at the latest data showing strong economic growth and labour market demand," he said. There is more evidence that economic growth remains above normal, or rather tight. He also mentioned that the labor market is no longer loose, which may lead to higher inflation risks and the need for more monetary policy.
Powell described the problems in the bond market in recent months as a tightening of credit conditions rather than a marked tightening of monetary policy. As we understand it, this is equivalent to the Fed raising the federal funds rate by 25 basis points at least twice (possibly four).
Another key indicator is the spread between the 2-year and 10-year yields, which narrowed today to -18 basis points from -108 basis points on July 4. In the past, when the bond market went wrong, the bond yield curve inverted before a recession because the Fed cut interest rates faster than bond yields. But this time the situation is markedly different. The banking crisis that erupted in March was quickly brought under control by the Fed, resulting in no recession because the market was rich in money and households and businesses were in good financial shape.
Yesterday's economic data was mixed. Despite weak sales of existing homes, this is partly due to a shortage of housing supply. The 30-year fixed mortgage rate rose from 7.00 percent to 8.00 percent this summer, leading to a drop in mortgage applications and weakening demand for homes.
As of Oct. 13, initial jobless claims fell to 198,000, confirming that the labor market remains strong. But as Powell said, good news can also be bad news. That's why bond yields are rising again, putting pressure on stock markets. If bond yields continue to rise, we may need to reassess our optimistic outlook for the economy and equities.