Bonds Brace For Tighter Policy

The bond market has specialized in playing defense for most of February as economic data and consistently hawkish Fed messaging paints a bleak picture. It’s hard to be too frustrated by the market’s logic. It’s not as if we’re witnessing some baseless selling spree. The NFP/CPI combination made a clear case over the past 2 weeks and now this week’s balmy retail sales data is joined by sub-200k Jobless Claims (adds to the Fed’s tight labor market mantra) and a surprisingly high reading in the producer price index. Once again, a Fed speaker is not far behind the data to reiterate its implications for policy. This time, it’s Mester putting the notion of a 50bp hike back on the table.

Mester doesn’t run the Fed and one Fed speaker saying “50bps” doesn’t mean it’s the consensus. Markets are trading accordingly–paying some attention to the idea, but not freaking out about it. This isn’t to say bonds are immune from freaking out for other reasons–just that this alone isn’t worth a massive sell-off. Fed Funds Futures show the relative impact of the AM data and Mester’s comments.

Stocks and bonds are undergoing the quintessential “Fed accommodation trading pattern.” This is our lackluster term for the sort of mirror image movement seen this morning (it also plays out over longer time horizons). The pattern is logical if we assume that both stocks and bonds rally when the Fed is seen being friendlier with policy and sell-off when the Fed may be getting less friendly (“selling” means the blue line goes down and the yellow line goes up, to be clear). Today’s big divergence began precisely at 8:30am ET with the econ data and accelerated at 8:45am with Mester’s comments.


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