Pricing In A Less Dovish Fed
Bond yields have drifted up 0.25% over the past month. Real yields on TIPs have barely budged from around –1%, so the move in bonds has translated into rising inflation expectations — now solidly above 2.5% for the next decade.
The persistence of negative real yields is surprising – with the Fed likely to finally rein in their bond buying, one might have expected this loss of support to be reflected in TIPs, but so far it hasn’t. Inflation-adjusted returns have been falling for many years. Negative TIPs yields undercut the concern of fiscal hawks about our ballooning debt, since there’s apparently no negative consequence.
The increase in ten year treasury yields has not been evenly distributed across the eurodollar futures curve. Over the past month, the market has factored in a more hawkish FOMC – one additional tightening of monetary policy by the end of next year (total of two) has been priced in. By the summer of 2023 almost two additional tightenings have been priced in (a 1% increase in total). The rise in inflation expectations is creating the anticipation of a reaction from the FOMC.
$120BN a month of quantitative easing has continued for too long. The $40BN a month of mortgage-backed security purchases is especially egregious, and the slothful exit from this strategy is turning out to be too slow. Following last month’s payroll report some even questioned whether tapering might be delayed, although the shortfall in employment was due at least in part to a shortage of workers. The FOMC remains focused on restoring the five million jobs still missing from pre-covid, and is willing to risk some inflation in the process.
The move in rates has pulled the market further away from the FOMC’s outlook. This Fed is the most dovish in living memory. It’s easy to see how chair Jay Powell could justify temperance before raising short term rates. In addition to the employment picture, widely acknowledged logistics problems won’t be fixed with higher rates.
Although Democrat politicians won’t accept credit, they’ve engineered rising oil and gas prices through curtailed investment so as to shift consumption to renewables – even if solar and wind aren’t yet up to the challenge (see Why The Energy Crisis Will Force More Realism). Reducing CO2 emissions requires more expensive energy (see Is The Energy Transition Inflationary?). Tightening monetary policy because of a green agenda seems unlikely.
Few policymakers want higher rates, but the “transitory” narrative is looking less compelling. The next public comments from FOMC officials will be worth watching to see if they confirm the more hawkish rate path currently in the market or remain true to their previous guidance. Powell has said they wouldn’t contemplate raising rates until they’d stopped buying bonds. This suggests 2H22 as the earliest they would raise rates, although they could also speed up tapering if necessary.
The net result is that the market is increasingly challenging the Fed’s benign inflation outlook and slow policy normalization. The FOMC’s dovish instincts are being challenged.
On a different topic, liberal commentators have been lambasting Senator Joe Manchin (D-WVa) as the one person thwarting efforts to combat climate change (see As Manchin Blocks Climate Plan, His State Can’t Hold Back Floods). This overlooks the 50 Republican senators also opposed to the Administration’s agenda, so Manchin’s concerns place him in the majority, even if that is inconvenient to progressives. It is democracy in action.
Manchin believes that the voters of West Virginia have more to lose from a system of rewards and penalties for utilities dependent on their adoption of renewables than they do from climate change. This seems rational – the drop in coal demand they fear would hit quickly. The adverse effects of global warming are loosely related – China’s choices on emissions are the most important and are unlikely to be swayed by West Virginia.
Once again we’re seeing the failure of climate extremists to move beyond broad yet shallow support, due to pretending the energy transition is costless. Voters in West Virginia don’t see it that way, which is why a more honest discussion about costs and benefits will be necessary before we make any real progress on the issue. Hopefully that is coming.
We have three funds that seek to profit from this environment:
Important Disclosures
The information provided is for informational purposes only and investors should determine for themselves whether a particular service, security or product is suitable for their investment needs. The information contained herein is not complete, may not be current, is subject to change, and is subject to, and qualified in its entirety by, the more complete disclosures, risk factors and other terms that are contained in the disclosure, prospectus, and offering. Certain information herein has been obtained from third party sources and, although believed to be reliable, has not been independently verified and its accuracy or completeness cannot be guaranteed. No representation is made with respect to the accuracy, completeness or timeliness of this information. Nothing provided on this site constitutes tax advice. Individuals should seek the advice of their own tax advisor for specific information regarding tax consequences of investments. Investments in securities entail risk and are not suitable for all investors. This site is not a recommendation nor an offer to sell (or solicitation of an offer to buy) securities in the United States or in any other jurisdiction.
References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in an index and do not reflect the deduction of the advisor’s fees or other trading expenses. There can be no assurance that current investments will be profitable. Actual realized returns will depend on, among other factors, the value of assets and market conditions at the time of disposition, any related transaction costs, and the timing of the purchase. Indexes and benchmarks may not directly correlate or only partially relate to portfolios managed by SL Advisors as they have different underlying investments and may use different strategies or have different objectives than portfolios managed by SL Advisors (e.g. The Alerian index is a group MLP securities in the oil and gas industries. Portfolios may not include the same investments that are included in the Alerian Index. The S & P Index does not directly relate to investment strategies managed by SL Advisers.)
This site may contain forward-looking statements relating to the objectives, opportunities, and the future performance of the U.S. market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involves a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of SL Advisors LLC or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made. r
Certain hyperlinks or referenced websites on the Site, if any, are for your convenience and forward you to third parties’ websites, which generally are recognized by their top level domain name. Any descriptions of, references to, or links to other products, publications or services does not constitute an endorsement, authorization, sponsorship by or affiliation with SL Advisors LLC with respect to any linked site or its sponsor, unless expressly stated by SL Advisors LLC. Any such information, products or sites have not necessarily been reviewed by SL Advisors LLC and are provided or maintained by third parties over whom SL Advisors LLC exercise no control. SL Advisors LLC expressly disclaim any responsibility for the content, the accuracy of the information, and/or quality of products or services provided by or advertised on these third-party sites.
All investment strategies have the potential for profit or loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client’s investment portfolio.
Past performance of the American Energy Independence Index is not indicative of future returns.
The problem is that if there is any kind of honest discussion about climate and costs it will become glaringly clear that the costs of adapting to any changes in climate are far less than the costs of reigning in fossil fuel use. The only other choice would be going nuclear – but, if that is out of the question than adaptation is the clear and obvious winner.
So we won’t be having any honest discussions. Will we?
Eric Rosengren and Robert Kaplan will likely be replaced by someone more dovish. Meanwhile, Powell needs to remain dovish in order to secure re-nomination. If he doesn’t get re-nominated we can expect the next Fed Chairman to be even more dovish. The writing is on the wall and it says “Print Baby Print!”