- Jerome Powell's testimony this week sought to reassure lawmakers and investors that the Central Bank can pull off the tricky task of bringing down a four-decade high inflation number without damaging the US economy. Powell indicated that the FED was on pace to start raising rates and reducing the balance sheet. However, he was clear; the policy moves were steps to move away from the ultra-expansionary emergency policy to fight the pandemic, not as a shift to a restrictive stance due to inflationary pressures.
- A key uncertainty for the FED is the impact of the Omicron Variant and how it will impact our markets over the next serval months. Many suggest a sharp drop in GDP followed by a slight recovery in mid-year. I believe rates should move in March, which will cause a shift in the yield curve. However, when the actual move happens, typically, you will see buying into our markets based on the "event" happening. I continue to believe the 10-yr T is at levels we will see for a while (between 1.625-1.875%), and MUNIs will find a pattern over the next couple of weeks.
- As the FED turns its attention to balance sheet normalization, the economic conditions and the size of the balance sheet will warrant changes from previous runoffs. In 2017 the FED used a "slow glide path" to dismantle the balance sheet, with the initial pace at $10B per month in 2017. I suspect in 2022, we will see twice this rate along with moves in the FED Fund's Rates up around .25 over the next couple of months. This move will impact all FI markets, including the QQQ type equity stocks. MUNIs should fare better than T Bills due to the tax advantage. However, I feel we have ~15 bps to move further before we see normalization.
- As of last week, many traders are starting to reduce their exposure to the 8–10-year part of the curve. With MUNIs starting the year down .7% due to the fears of inflation, many dealers seek longer-dated securities to pick up as much yield as possible. Many, including myself, believe that the rate hikes will slow down this year. Until then, longer dated (2030-2039) paper will be a better buy than the middle of the curve. Ultra-Short paper (less than 14 months) will also be a safe play, as investors will want bonds that mature "after" the hike.
- The jobs report was good and showed that we are most likely at maximum employment; this will give the FED reasons to move forward. However, the only material event that might make them hold back is the variant. Last week while in France, it was evident that the EU nations were shunning Americans. Masks were mandated both inside and out, and people were wearing them. Local authorities checked COVID vaccination cards, and you were denied entry if you did not have one. Also, temperature checks were taken at all the large galleries, and you were turned away if you had one remotely close to the danger zone. My takeaway was that the EU Nations treat this variant much more seriously than we do. I am surprised the markets in the US are doing so well with the looming issues that plague our country; however, Americans (and most of the world's population) have short memories.
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