Buy The Dip Or Sell The Strength? It Depends

Fed chair made it clear last week that things have not deteriorated enough for them to act. In this atmosphere, the 10-year rate can head toward two percent. Equities, in all probability, will not like that, even though they are oversold near term.

In the week to last Wednesday, the Federal Reserve purchased $19.9 billion in treasury notes and bonds, to $4.15 trillion. A year ago, it held $2.03 trillion in these securities. Back then, the central bank was buying so aggressively that in April its holdings went up by $1 trillion over four weeks. On that basis, the pace has slowed down. That said, last week’s four-week change was $85.6 billion, which was the highest since last June (Chart 1).

Treasury rates on the long end have been firming up. It is too soon to say if the Fed is trying to influence the long end of the yield curve by increasing their purchases of notes and bonds. Last Thursday, Chair Jerome Powell essentially said at a public event that he is not too worried by the recent uptrend in long rates. After all, the Fed has been spending up to $120 billion/month in purchases of mortgage-backed securities and treasury notes and bonds.

On the day Powell spoke, the 10-year yield touched 1.63 percent intraday before settling down at 1.55 percent. This was the second time rates crossed 1.6 percent in a week before pulling back.

A year ago when Covid-19 fears were pervasive, stocks were in free fall and bonds were getting bid up, the 10-year bottomed at 0.4 percent. Since that low, rates have steadily climbed higher, breaking out of one percent in the first week of January. Mid-February, bond bears (on price) took care of 1.2 percent and then 1.4 percent two weeks ago (Chart 2).

As things stand, markets are clamoring for some version of Operation Twist, in which the Fed sells short-term notes and buys long-term notes and bonds – some level of yield curve control in which the long end is capped.

Right here and now, Powell is saying no to that. If he sticks to his guns, the 10-year rate could very well head toward two percent in due course. Eventually, markets have a way of getting their own way – sooner or later. That was true with Alan Greenspan, true with Ben Bernanke and true with Janet Ellen. Unless Powell shows the fortitude of Paul Volcker when the time comes, markets will end up leading the Fed. They will do so by throwing tantrums in both the bond and stock markets.

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