“Stock investors had better hope the Federal Reserve raises rates Wednesday. Yes, seriously — it beats the alternative.”
That is Spencer Jakab, and the argument is worth following because it describes a genuine regime change in what markets are afraid of.
The old reflex
For at least the past fifteen years, the most important thing for equity investors to know on almost any given day was what rate setters might be thinking. When a piece of economic news was clearly good — higher-than-expected jobs growth, say — it was basically a coin flip whether the S&P 500 would rise or fall. Good news could be bad news if it raised the odds of a hike, which was read as a drag on stock prices and especially on rate-sensitive technology companies.
Sometimes the economic tea leaves were hard to read, but loose-lipped Fed officials left little to chance. By the time decision day arrived it was a foregone conclusion.
What broke it
Warsh’s first meeting as chair, in late July, was not like that. Many bond traders were betting on a hike and were wrong. And the market’s response to the hold was not relief — Jakab writes that Warsh’s “clumsy explanation played a role in pushing up longer-term interest rates set by the bond market.”
That is the whole reversal in one sentence. The Fed held, and long rates went up. Doubts about how committed rate setters are to tackling inflation have hurt the central bank’s sway over the bond market.
Which brings the risk into focus. On Monday the 10-year crossed 5%, hitting its highest intraday level since 2007. The market reaction to leaving rates unchanged again could be a repeat of July, or worse.
The most influential bond manager in the world, unimpressed
Jeffrey Gundlach, chief investment officer at DoubleLine Capital, said on a podcast last week: “There’s something about Kevin Warsh that I don’t fully trust.” He said he would expect long-term interest rates to rise fairly significantly in the aftermath of a decision to hold rates steady.
A hold would now be a far bigger surprise than in July, in no small part because of Warsh’s tough talk on inflation at a gathering of central bankers last month. The market-implied chance of a hike was one-third in mid-August, two-thirds after his speech, and 95% by Tuesday, per CME FedWatch. The gap between the 2-year Treasury yield and the Fed’s overnight rate widened to a multiyear high on Monday — which usually means the bond market expects an increase, and this time pencils in at least one more quarter-point move soon.
A vocal objection could come from the president, who appointed Warsh and wants cuts. Jakab’s response is four words: “be careful what you wish for.”
The idea underneath, which outlasts the week
Credibility is a strange asset. You cannot buy it, you cannot hold it, and it does not appear on any statement. But every long bond in a portfolio is priced partly off somebody’s estimate of how much of it the central bank has.
That is why the arithmetic here is asymmetric, and why Jakab lands where he does: one or two rate increases will hardly affect Main Street, or Wall Street for that matter. An out-of-control Treasury market sure would.
For a household, the translation is modest and useful: stop reading the Fed’s decision as a verdict on stocks, and start reading it as a statement about the long end — which is where the mortgage, the bond fund and the borrowing costs actually live.