Yields Are Spiking Because Bond Traders Don’t Believe Powell

Yields are up and stocks are down. The market sunk this morning as Treasury yields spiked again after yesterday’s dismal 2-year Treasury auction. The tech-heavy Nasdaq Composite endured the brunt of the losses, plunging 2.5%. The S&P dropped 1.7% while the Dow fell 1.3% as well.

And though the 2-year Treasury auction disappointed, it was the 10-year Treasury yield that stole the show today when it climbed to 1.558%, temporarily hitting a three-month high.

Bond traders are convinced that the Fed will taper its asset purchases just like Fed Chairman Jerome Powell indicated last week. Wall Street expects the tapering to actually start in November.

In anticipation, the bond market is pivoting en masse.

“The market’s been steadily coming around to the reality that yields were awfully low relative to the fundamentals. Now the Fed is shifting, and everybody’s shifting their positions, all at once, as we tend to do,” explained Kathy Jones, who serves as the chief fixed-income strategist at the Schwab Center for Financial Research.

Other analysts are calling for a rotation into value like last year’s “tech wreck,” when rising rates prompted a rapid tech selloff.

“I’m having actually a little deja vu to last fall, if you remember last September, when we saw interest rates move a little bit and the reaction in tech,” Jeff Kilburg, chief investment officer at Sanctuary Wealth, said.

“And the selling pressure in tech really was a catalyst last fall for the reflation and rotation trade, and again here we are.”

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Driving rates higher as well is the belief that inflation’s here to stay – something Powell himself admitted in his post-FOMC meeting remarks last Wednesday.

“Inflation is elevated and will likely remain so in coming months before moderating. As the economy continues to reopen and spending rebounds, we are seeing upward pressure on prices, particularly due to supply bottlenecks in some sectors,” Powell said.

“These effects have been larger and longer-lasting than anticipated, but they will abate, and as they do, inflation is expected to drop back toward our longer-run 2 percent goal.”

Powell remarked that the Fed was wrong about its inflation projections in the past. Now, though, he says the FOMC has a better handle on it.

The bond market isn’t buying it though, as evidenced by the sharp bond selloff (and resulting yield spike) over the last two days. Inflation is undoubtedly a problem in both the short and longer-term.

If it wasn’t, why would Powell be happy with tapering before the US reaches “full employment?” Several months ago, he said the Fed wouldn’t taper until the US reached pre-pandemic employment levels (3.5% unemployment). Unemployment idled at 5.2% in August.

The truth is that the Fed recognizes the danger inflation poses as well as the many asset bubbles that emerged. US housing prices have spiraled out of control, crushing buyer sentiment. Equities appear vastly overvalued as the US economy now faces a slowed recovery, too.

Yields are unlikely to keep up their breakneck pace, which should help stocks recover in the coming weeks. But make no mistake about it, turbulent times lay ahead.

Regardless of whether the Fed pushes its taper back a few months, tapers on time, or decides to not even taper at all.

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