The Federal Reserve’s policy was perfect during the worst coronavirus crisis, but its near-annual streak seems to be over. Now, as longer-term treasury jumps and financial markets raise expectations of rising interest rates, Wall Street wants action. He didn’t get it today.
Federal Reserve Chairman Jerome Powell said Thursday that rising bond yields last week “caught my eye”, but said the policy remained highly adaptable and did not suggest a new “turnaround” in policy. The Nasdaq-led resumed sale on Thursday afternoon as Treasury yields jumped.
The Fed’s policy may change at the March 16-17 meeting. However, investors were looking for clues as to what the politicians would do, as the head of the Fed Powell took part in a discussion at the summit of the Wall Street Journal, which began at 12 o’clock ET.
Powell said “troubled financial market conditions” or widespread tightening of financial conditions would cause a change in policy. But he did not say that recent market fluctuations met these tests.
The stakes are high: If the Fed manages to quell the bond market riot, the stock market rally could resume.
In the volatile stock market stock on Thursday, the S&P 500 climbed into positive territory before Powell’s speech, but fell sharply after he spoke, collapsing below the 50-day line. The Nasdaq broke its 50-day average in the middle, losing 2.7 percent, then sinking 2.2 percent in Powell’s comments. The Dow Jones, which did not fall much on Wednesday or Thursday morning, fell more than 1%, testing its 50-day line.
The yield of the 10-year treasure rose by seven basis points to 1.54%.
The Federal Reserve is no longer “in the right place”
For months, the head of the Fed Powell has said that the central bank’s policy is “in the right place.” Last week, he gave the first clear sign that this was no longer the case. The treasury’s auction of $ 62 billion in 7-year government bonds on Thursday drew the weakest demand in more than a decade. The ten-year treasury yield, which had remained below 1% before Democrats seized the Senate in two run-off elections in Georgia on January 5, rose to 1.61%. This is the highest value since February 2020.
As early as December, the Federal Reserve did not show an increase in interest rates before 2024. However, “markets estimate an increase in interest rates by mid-next summer,” Wells Fargo economist Sarah House said on Tuesday, calling for an inflation forecast.
Whether the Fed’s policy is right or not, skeptical financial markets can tighten policy, creating risk on stock prices and slowing recovery. Further increases in treasury profitability could also dampen enthusiasm for the Democrats’ large infrastructure and tax package, which is expected to follow the $ 1.9 trillion stimulus.
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Operation Twist Redux?
Wall Street increasingly expects the Fed to adopt a policy called Operation Twist, which was last used in 2011 and 2012. The Fed then sold $ 667 billion in short-term profits to the Treasury and used those funds to buy long-term debt.
The Federal Reserve now holds government securities worth more than $ 1 trillion with a maturity of one year or less. The additional $ 1.8 trillion in government securities has a yield of one to five years.
Repeating Operation Twist can help retain long-term income, which is key to mortgages and car loans. This could have a positive effect on the federal deficit, as the Fed’s holdings would generate higher interest payments, which the central bank then transfers back to the treasury.
“Twist, the simultaneous sale of US government securities and the purchase of longer-term ones, is the ideal policy stipulation for the Fed,” Bank of America strategist Mark Cabana wrote this week.
Operation Twist Impact on S&P 500, Nasdaq, Treasasures
If the Fed adopts Operation Twist, “the melting of stock prices will continue, led by Nasdaq,” wrote Ed Yardeni, chief investment strategist at Yardeni Research, on Tuesday.
DataTrek Research co-founder Nicholas Kolas found that the experience of Operation Twist and its aftermath “showed that the Fed could absolutely suppress long-term interest rates by 100 (basis points) or more.”
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Federal Reserve Plan B: Punt On SLR
If the Fed is not ready to turn around, there is another option on the table that can help settle financial markets. At the end of March, the Fed must stop exempting banks from a regulation known as the additional leverage ratio, or SLR.
Last year, in response to Covid, the Federal Reserve began excluding bank holdings of U.S. government securities and reserves parked with the Fed from calculations of how much capital reserves financial institutions should hold.
Banks could respond to the restoration of this rule in a number of ways, but one would be to ease government coffers. This can contribute to upward pressure on yields, even when the new stimulus stimulates a new supply to the treasury.
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