Friday, October 24, 2014
Equities v. Treasuries; Pricing Patient Fed, Not Growth Outlook Flip-Flop
Price action following the October 15-16 fall and recovery in U.S. equities and Treasury yields continues to indicate that an extreme in both was reached that will usher in a lengthy recovery period. However, equities have thus far outpaced Treasuries in that recovery. This situation may indicate a greater prevailing belief that the Fed will be more patient in the timing and application of policy normalization. If the Fed is expected to be more patient in the process of policy normalization, delaying the initiation and tamping down the pace, we would expect some liquidity advantage for equities and a lower baseline forecast for Treasury yields.
A growing consensus prevailed prior to mid-September that the Fed was likely to initiate its first policy rate move in mid-2015 or slightly sooner. This has changed and consensus is closer to a view of early 2016 lift-off than early 2015.
Here in resides the nugget; If the Fed is consistent with its rhetoric in the FOMC meeting statement on Wednesday October 29th, then we should expect a more spirited advance in Treasury yields. Even though scores of economists will caution that the Fed is unlikely to dramatically change the rhetoric, many have come to expect some confirmation that the Fed will be ‘less hurried’ in the application of restraint. Without the Fed backing off from its growth forecast or refreshing disinflationary concerns, economic agents will move pricing of accommodation removal back toward mid-2015, thus pushing Treasury yields lower.
Thus far, 10 year Treasury yields have risen from a 1.87% low on Oct 15th to 2.3% yesterday, recovering 57% of the 75 basis point yield fall from the mid-September yield high of 2.62%. Conversely, the S&P 500 Index Emini (ESZ4) registered a high of 2014 in mid-September and fell to 1813 last week before recovering to 1956 yesterday. This represented a 71% recovery of lost ground.
Unless the Fed gives somewhat heightened attention to a new concern for declining inflation or a greater unease about slowing global growth, we should expect Treasury yields to rise further and for the recovery in Treasury yields to catch up to the recovery in equities.