Uncertainty In The Spotlight After Fed Meeting

Historical Stock, Securities, Certificates, Fund, Bonds

Wednesday’s policy meeting was supposed to be a non-event. The Federal Reserve was widely expected to leave interest rates pinned near zero while the central bank reaffirmed that its view that the recent surge in inflation is temporary. Both forecasts proved to be correct, but the Fed hinted that it is considering raising rates sooner than expected. The news sent markets reeling and analysts reconsidering how vulnerable the economy is to tighter monetary policy.

Although there’s no sign that the central bank will raise rates any time soon, the mere hint that higher inflation may change the calculus triggered volatility across global markets on June 18. Notably, the reflation trade that has dominated trading this year came under fresh scrutiny.

“The surprise shift [of] more hawkish [comments] from the Fed on risk management grounds Wednesday reverberated through financial markets globally Thursday, with violent moves across and within asset markets as investors liquidated inflation hedges and faded reflation trades,” says Krishna Guha, vice-chair of Evercore ISI.

Indeed, the US dollar surged while US interest rates retreated. Meanwhile, commodities took a hit, including gold and energy. Stocks buckled, too. The slide in the 30-year Treasury yield is particularly striking. Presumably, this long maturity bond is highly sensitive to inflation expectations. If so, this rate is sending a message that the reflation trade is fading. In the wake of Wednesday’s Fed meeting, the 30-year rate fell to 2.11% (June 17), a four-month low.

The decline in the 30-year yield, if it continues, would be a strong sign that the market’s recent anxiety about higher inflation is due for an attitude adjustment. The same applies to interpreting prices for commodities, which tumbled yesterday. As research from Citigroup indicates (via John Authers at Bloomberg), an extended decline in materials prices could be a sign that the recent runup in inflation is set to reverse.

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Disclosures: None.

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