Another Big September Fed Breakout
Wednesday was a confirmation of a hawkish Fed that won’t care about the economy until it sees actual damage, and even then, only if that damage coincides with the expected drop in inflation. More important than Powell’s message during the press conference was the takeaway from the Fed’s dot plot. The market was positioned for this, but subsequent trading suggests “not positioned enough.” Domestic traders began shifting their selling focus away from the shortest end of the yield curve this morning. This is their way of acquiescing to the idea that the Fed will attempt to keep rates high for as long as possible (or as long as it takes for inflation to come back to target levels). Now for the plot twist: virtually all of the first paragraph was copied and pasted from last September’s post-Fed Thursday (here’s the link to the original). Pretty spooky… In the present day example, we have the same sort of international follow-through in the overnight session following a “higher for longer” nudge from the Fed, but we also have stronger jobless claims data and a higher inflation reading inside the Philly Fed data (of the two, the labor market data is the bigger mover). Comparing the present example to the big picture, we find similarities and differences. In both cases, the Fed day reaction represented a technical breakout of a recently achieved high yield: But the 2022 bond market was in a much greater state of flux. The yield curve had only recently inverted and 2s had been selling off faster and faster compared to 10s. Contrast that to 2023 where 2s have been far more sideways compared to 10s. While it can take months, the stabilization of a curve inversion trend is another step toward an eventual rate reversal. The scary caveat is that some past examples show multiple head fakes back toward an un-inverted curve before it finally takes. The following chart shows those head fakes (note, this is 10s vs 1s as opposed to 10s vs 2s, due to better historical data availability in 1yr Treasuries).