Stocks matter, even for bond traders

Federal Reserve Chairman Jerome Powell finally decided that the stock market’s tantrum over the past month was too noisy to ignore.
Traders bemoaned the fact that Powell considered the central bank’s balance-sheet runoff to be on “automatic pilot.” So he softened his tone on January 4 during a panel at an American Economic Association meeting in Atlanta, saying policy makers “wouldn’t hesitate to make a change” if necessary.
Investors were unhappy that Powell shrugged off swings in the stock market as “a little bit of volatility” that shouldn’t do much harm to the economy. So he assured them that the Fed is listening carefully to the market’s concerns about downside risks. He and his predecessor, Janet Yellen, both reminded listeners about 2016, when the median projection among officials was for four rate increases, yet they only went through with one.
All of this sounds dovish and explains why the S&P 500 Index rose as much as 3 percent as Powell, Yellen and Ben S. Bernanke spoke and extended gains afterward. But that doesn’t quite match up with the move in the US Treasury market. Two-year yields soared as much as 12 basis points, the largest intraday increase since November 2015. Ten-year yields rose 11 basis points. Usually, such a move would happen only if expectations for further interest-rate hikes increased drastically. But fed funds futures indicate that bond traders expect the Fed to stand pat, at best, in 2019 and cut rates as soon as mid-2020.
Now, Treasuries had almost certainly rallied too much to start the New Year — relative strength index analysis shows that two-year notes were at the most “overbought” level since early 2008, while 10-year and 30-year debt veered into similar territory.
A few months ago, when Treasury yields increased and stock markets declined, many investors fretted about a breakdown in the traditional correlations between the two assets. Bonds have rallied lately as equities have declined, and vice versa.
The bond market still isn’t pricing in anything remotely close to another full interest-rate increase in 2019, even after a blockbuster employment report that showed US employers added 312,000 workers in December, exceeding all forecasts. If economic data remain solid, can traders start pricing in a rate hike in 2019 without spooking stocks?
It’s often said that bonds are smarter than stocks, so how Treasury yields move in the coming week, particularly around the January 9 release of the Federal Open Market Committee’s minutes of its December meeting, may provide further clues to how all these competing interests will work themselves out.
—Bloomberg