Ed Yardeni coined this term decades ago, the “bond vigilantes,” and those large pools of capital who are supposed to deliver fiscal discipline through our debt markets are still in play today. Question is, how much riding is left for them to do – how much higher will rates go?
Coming out of an era of near-zero interest rates into a more normal environment has been a challenge for investors. The Fed has long had its detractors and the rapid rise that has been engineered by the committee this time around has drawn the howlers, veterans and newbies out in droves – in some cases, rightfully so. In fact, we hope the Open Market Committee hears the screams coming from all angles and adjusts policy accordingly, with a statement that makes clear the Fed is going to press pause for a while.
Still-strong GDP numbers support our ongoing view that rates will remain elevated for longer than some are hoping. However, the increasing likelihood of an accident caused by hiking so quickly means to us that a clear message the Fed will cool its jets makes the most sense.
As for a return to cutting rates, the always articulate John Rutledge outlines the Fed’s dilemma, noting particularly the flawed dataset officials are using for policy formulation. His key points:
- Fed blunders, keeping rates too low, too long, then raising rates too high, too fast, and brought us to the brink of a credit crisis.
- A major cause of their blunder was misreading flawed inflation reports. Correcting for imaginary owner equivalent rent (OER) brings the headline September CPI inflation rate down from 3.7% to just 1.96%, slightly below the Fed’s 2% target.
- Inflation is lower and real interest rates are higher than the Fed thinks they are. The Fed should end QT and reduce rates now.
Meanwhile speculation abounds in the bond market.
Not only are speculators saying a lot, but they are also doing a lot. We tend to put more faith in actual trades as opposed to relying on sentiment polls to gauge the mood of market players. Indeed, look at the open contract volume of the CME for interest rates: bets placed on rates have more than doubled, leading to the 10-year Treasury rates above 5%, alarming the markets. However, the silver lining could lead to the vigilantes completing the Fed's bidding.
The markets will be most focused on the press conference immediately following the Fed’s decision today. The meeting is the simplest one in a while, actually: markets will be most focused on the press conference immediately following the Fed’s "decision" on rates, which will be no hike this month.
Because interpretations of their forward guidance could be all over the board, an unclear statement will likely lead to more volatility in both stocks and bonds, albeit part of a bottoming process that should soon end for the stock market. A clear statement from the Fed could mean the bottom is in for stocks.