Equities were seemingly caught off balance with the Fed’s ‘surprise hawkish shift’. From mine – there was very little surprising about it – you only needed to look at the data. However, what I was more interested in was how Powell would explain why they were cutting rates. As it turns out he struggled – leading to a small sell off in stocks. The irony was Powell did a better job of explaining why rates should not be lowered (which is obviously at odds with their decision to cut).
Interest Rates / Bonds
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Inflation x Rates = Uncertainty
The stock market could not be more optimistic. And perhaps not since the dot.com bubble of 1999 – have investors been so sure of the future. Excited by a business friendly government coming to power; lower inflation; consumers continuing to spend – what’s not to like? I can think of one thing…. valuations. If buying stocks today – you’re paying through the nose. And for me – that increases your risk.
The Bond Vigilantes Strike Back
Several weeks ago I suggested investors consider reducing their exposure to 10-year treasuries. At the time, the world’s most important debt security was yielding around 3.80%. They would continue to fall to a near-term low of 3.60%. In this case, the timing was good as these yields have rallied some 60 bps in turn crushing bond prices. For example, EDV and TLT have dropped more than 10%. So why are 10-year yields rising in the face of Fed cuts? There’s a good reason: term premium. Bond owners demand a premium if owning the debt of a fiscally irresponsible government. And this has major implications for investors…