What’s the market saying about the Trump win?
With respect to today’s FOMC meeting, Powell needs to carefully consider where he wants to attempt guiding yields
Federal Reserve Chair Jerome Powell | Sérgio Garcia/Your Image for ECB/”ECB Forum on central banking 2023″ (CC license)
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After Trump’s election win was confirmed (and with a likely sweep of Congress), markets began to digest the news.
In bond markets, the major factor was a Congress sweep that will allow unrestrained legislation from the Republican party. This — paired with concerns around a re-accelerating economy and potential inflationary policies, such as Trump’s tariffs — sent long bond yields soaring globally, but especially domestically:
At the same time, the DXY soared as global investors anticipated higher nominal growth and a roaring economy in the US. That said, half the move has reversed today alongside a calming down of long bond yields.
So what does this all mean? And what were the implications for the Fed as it entered its FOMC meeting today?
As Jim Bianco shows in the chart below, this reverse in yields on the long end since the Fed’s first rate cut is historic:
Regardless of what the Fed does to the short rate (i.e the fed funds rate), the vast majority of the economy borrows and lends on the long end of the yield curve, such as mortgages.
Therefore, regardless of what happens to the short rate, the surge in long bond yields has been tightening financial conditions.
With respect to today’s FOMC meeting, Powell needs to carefully consider where he wants to attempt to guide yields. There are currently two evolving approaches:
Andy Constan of Damped Spring Advisors believes that for yields to come down and counter-intuitively ease financial conditions, the Fed needed to be more hawkish today and potentially pause its cuts. In his view, more rate cuts could actually tighten conditions as bond vigilantes show up and send bond yields higher — doing the tightening the Fed refuses to do.
On the other side is Tom Lee, who believes the Fed needs to be even more dovish. This is because a large portion of what comprises the price of long bond yields is expectations on short rates for the maturity of the bond.
With the FOMC’s 25bps cut today and no signal yet of an end to QT, it’s looking likely the Fed will continue to wait and observe how its current rate-cutting path transpires and is digested by markets.
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