E-mini S&P 500 Futures (June): Settled at 3896.50, up 23.25
E-mini Nasdaq-100 Futures (June): Settled at 12,749.25, down 39.50
It’s Fed Day: the committee’s policy decision, economic outlook, and interest rate projections are due at 1:00 p.m. CT. Yields of longer duration Treasuries are climbing as many analysts say a dovish Fed is simply not enough anymore. Although inflation hasn’t shown up via headline economic indicators, it certainly has arrived.
We’ve pointed to it here many times over; the price of lumber has doubled to a record, prices across the energy space are at the highest level since 2018, and many agriculture commodities are at multi-year highs. The committee’s steadfast notion that there’s no inflation and that any sign of such will be transitory has suppressed short-term rates but lifted the ceiling farther out the curve.
The bond market has cratered thanks to a melting pot of many factors, including the notion that such unprecedented levels of accommodative policy will eventually create massive inflation, the aforementioned real-price inflation in commodities right now, an increase in economic activity due to reopenings, and massive debt printing.
As we’ve pointed to many times before, such an increase in rates will force investors to choose between a risk-free return or expensive stocks. The Fed’s handling of this melting pot today will be critical.
The committee can stay the course and remain dovish, but simply saying that they’ll allow inflation to run hot won’t be enough to control the long end of the curve. If reiterating their accommodative stance until full employment is their only course of action, they must emphasize underemployment levels, deflecting from the headline U-3 number.
As of February, U-3 is 6.2% versus a U-6 of 11.1%. Furthermore, it’s no secret that without fiscal measures from Washington in December and again last week, the jobs picture had quickly deteriorated. Reopenings certainly will help, but there are parts of the job market that won’t return, ever.
You may have seen the acronym SLR this week. It stands for Supplementary Leverage Ratio and refers to the amount of equity a bank must hold relative to their leveraged exposure. During tightened cash conditions, the Fed has relaxed SLR calculations to exempt U.S. Treasuries.
At the onset of the pandemic, exempting U.S. Treasuries allowed banks to hold more leverage, so to speak, and this demand supported the Treasury complex and thus suppressed rates. The deadline for this exemption is March 31st, but the Fed could address extending it today.
Last, but certainly not least, is yield curve control. You may have heard someone point to Operation Twist; we’ve mentioned it here. This was implemented by the Fed initially in 1961 and then again in 2011.
Here, the Fed sells shorter-dated Treasuries and buys farther down the curve. The result is an artificial flattening of the yield curve: 2-year Note yields would inch higher ever so slightly and 30-year Bond yields would fall to a larger degree. The Fed is currently buying bonds at a pace of $120 billion per month, and extending the duration of these purchases would support risk assets.
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