The Week Ahead – Don’t Fight the Fed

Welcome to “The Week Ahead” where we take a moment to provide our thoughts on what we can expect in markets and the economy during the upcoming week.

A bounceback week as the S&P 500 gained over 4% for the week while at the same time the 10-year U.S. Treasury yield inched up to close the week at 2.87%. With inflation being the talk of the town (besides this weekend’s NBA All-Star game, congrats to Team LeBron for an exciting game!), it’s a good time to look back at the Fed’s posturing last year. The Fed was early to note that some events such as the surprise plunge in wireless telephone services last spring and the various hurricanes were transitory factors, and not consistent long-term drags on inflation. Even after starting balance sheet normalization in the fall while inflation was still below their target, the Fed continued to subscribe to the view that inflation was just around the corner. Their view was that a continuing tightening labor market combined with a robust economy would eventually lead to wage growth, which would then produce more inflation down the road. The broad market seemed to shrug off that thesis until the most recent wage growth report which brings us to the market volatility that we’ve seen over the last few weeks. There’s a common adage, “Don’t fight the Fed”, and in this instance many investors had been fighting the Fed on inflation views. Bond yields are typically looked at as safe investments and U.S. Treasury yields are even often referred to as the “risk-free rate”. When they get re-priced for risk (in this case rising interest rates), then risk gets re-priced across the board.

With Monday’s holiday, this shortened week will be highlighted by the release of the FOMC minutes on Wednesday. With less than a month before the next meeting, investors are currently pricing in an 83% chance of a rate hike occurring when the Fed reconvenes. Once again, more hawkish language could further rattle bond investors. Per FactSet, an outflow of $3.1 billion in fixed-income ETFs occurred for the week ending February 15. LQD, an intermediate duration fixed income ETF, saw an outflow of $921 million for the week.

Data deck for February 17 – February 23: