Powell Could Trigger a Bond “Short Squeeze” Today

Federal Reserve Chairman Jerome Powell

Dow stocks saw an uptick today with traders eagerly awaiting the Federal Reserve’s imminent interest rate verdict. The blue-chip index rose by 210 points, marking a 0.6% increase. Concurrently, the S&P 500 edged up by 0.2%, while the Nasdaq Composite experienced a slight dip of 0.1%.

Following its peak, the highest since 2007, the 10-year Treasury yield took a step back today. The prevailing sentiment among investors is a hope for market rates to pivot as inflationary pressures subside and the Fed potentially concludes its rate-hiking spree.

The consensus is that the Fed will maintain the status quo on rates at 2 p.m. ET. However, the spotlight will be on the summary of economic projections and Jerome Powell’s press briefing, as traders seek insights into the possibility of another rate hike this year.

Optimism surrounding the Fed’s capability to curb inflation without pushing the economy into a downturn buoyed certain bank and industrial equities. Notably, the SPDR S&P Bank ETF rose close to 1%, while industrial giants Caterpillar and Deere witnessed gains exceeding 1% and 2%, respectively.

Sam Millette, a fixed income strategist at Commonwealth Financial Network, commented, “Instead of focusing on the federal funds rate at this meeting, market participants will be keeping a close eye on the Fed’s dot plot and Fed chair Jerome Powell’s post-meeting press conference for hints on the future path of monetary policy.”

Recalling past moves, the central bank elevated its benchmark rate in July, reaching a level not seen in over two decades. Current Fed funds futures indicate a modest 29% likelihood of a rate hike come November.

Bank of America strategist, Ralph Axel, highlighted that the “new driver” of the 10-year yield is rooted in market expectations regarding Federal Reserve rate reductions for 2024. As the Fed is poised to revise its policy rate trajectory through its dot plot forecast today, Axel emphasized the significance of the 2024 projections. He noted potential shifts in the benchmark yield based on varying rate cut scenarios for the upcoming year.

Axel further elaborated on the potential market dynamics, stating that if rate cuts are excluded from the 2024 forecasts, “the curve steepens, with the 2-10 slope performing the best out of 2-5, 2-10, 5-10 and 10-30.”

He also pointed out that projections beyond 2024 might hold less sway due to their speculative nature. The Fed’s long-standing dot, consistently at 2.5%, remains a focal point as it mirrors the central bank’s stance on the ‘neutral rate’, a topic that has garnered significant attention lately given the market’s resilience to rate hikes.

Also worth noting is that institutional bond traders are currently net short bonds at extreme levels unseen since November 2021. The last time this happened, a bond “short squeeze” emerged, popping bonds sharply higher which caused yields to crash. This led to a major 3-day rally in early December.

If Powell gives traders a dovish surprise today, a similar reaction is to be expected. Keep in mind, however, that right after the 2021 December rally, stocks entered 2022’s bear market.

So, even if Powell pleases bulls today, that doesn’t mean those gains will necessarily stick around through October despite the month’s seasonally bullish bias.


Please enter your comment!
Please enter your name here