Talking Data – Powell’s Hawkish Taper + Dovish Rate Hike Speech

In our latest installment of Talking Data, Jim and Ben decipher the messaging in Powell’s speech at the Jackson Hole Symposium and the muted market reaction.

    • Risk assets up and bond vol down, why such a passive reaction by investors?
    • Does the taper matter relative to rate hikes?
    • What will bring back UST volatility and rising yields?

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Investors are faced with the fourth taper of bond purchases since the financial crisis. Bottom line, these cycles of ‘unconventional’ monetary policy have become too commonplace to easily disrupt financial markets. Investors are now pre-programmed to believe quantitative easing can be turned on and off like the spigots on our homes. 

*POWELL: ILL-TIMED POLICY MOVE COULD BE PARTICULARLY HARMFUL
*POWELL: DELTA POSES NEAR-TERM RISK BUT JOB PROSPECTS ARE GOOD

US Treasury volatility expectations tumbled into and following Powell’s speech on Friday. The premium assigned to one-month USD swaption volatility has completely evaporated, which is typical during a drop in yields. 

Additionally, US 10-year nominal yields already reside within shouting distance of fair value generated by the Federal Reserve’s rhetoric. The opportunity for a rapid rise in yields was just not present unlike in February and March when fair value was ~100 basis points higher than actual yields. 

The only minor surprise was the increased focus on inflation and its potential for persistence into 2022. 

*POWELL: ‘SUBSTANTIAL FURTHER PROGRESS’ TEST MET FOR INFLATION
*POWELL: CANNOT TAKE FOR GRANTED TRANSITORY INFLATION WILL FADE
*POWELL: CURRENT INFLATION A CONCERN BUT LIKELY TO BE TEMPORARY

Inflation as a topic within official communications has jumped to the highest since the turn of the century. Employment continues to reign supreme, while financial stability (so-called 3rd mandate) has become a major afterthought for officials. Tranquil markets including near record-low foreign exchange volatility have made central bankers and investors quite comfortable.

Officials’ comments about transitory inflation have seemingly peaked with economists expecting headline inflation above 5% YoY well into 2022. 

Demands for patience have also seemingly peaked, implying members (especially regional presidents) are becoming increasingly sensitive to inflationary pressures.

Ultimately, the real excitement including rising real yields will not occur until all three measures below reverse in trend. For now, agreement has significantly slid, but concerns over financial stability and ambiguity in messaging remain very muted. The opportunity for a rebound over the near-term in volatility expectations across the curve will likely take a truly unexpected event.

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