Markets nervous as Yellen speaks openly about rates

We can explore the actual statement in greater depth, but the initial reaction here was to push the S&P 500 into 4128, with tech getting hit (NASDAQ futures were down -2.8%) shortly after the cash session open. Implied vol pushed higher, with the VIX index into the 100-day MA at 22%, before vol sellers kicked in and we’ll be on the lookout for the VIX to hold above 20% in the days ahead.

The interesting aspect here is that despite talk of rates going up US Treasuries turned bid, with 10’s trading from 1.62% to 1.55%, while interest rates markets (Eurodollar futures) priced out a small degree of hikes by 2023. The USD rallied, notably against NZD and AUD, with the DXY finding supply into 91.40, while classic risk aversion plays such as short AUDJPY worked well.

While parts of the market saw classic risk aversion, we’ve seen commodities working well, notably Crude, lumber, corn and wheat, in turn supporting inflation expectations. The default hedge against inflation remains to own deep value stocks, with financials and energy continuing to work well.

Gold has kicked back to $1777 (low in US trade of $1771), even though real Treasury yields have moved further negative, which perversely was the source of inspiration behind the move higher yesterday.

As the session wore on calmer heads prevailed and traders heard from White House (WH) Press Secretary Psaki that the WH takes “inflation very seriously” and that it understands and respects the independence of the Federal Reserve. Ultimately, we all know that the investment made by the Biden Administration will need to be offset by tighter monetary policy in the future, so these comments should in no way shock but hearing it from a high-level official makes the market nervous.

Again, a world where we see lower liquidity from central banks is a world questioning how financial assets perform, as so much of the future performance has been brought forward. As the gravy train is pulled away, it brings the extreme valuation into question and ascribes a lower risk premium. This will mean higher volatility.

We’ve also seen comments from a WH economic official which left some uncertainty about the future of Jerome Powell at the helm of the Fed – this is something that will get more and more attention as we head later into the year, with Powell’s term as Chair due to expire in Feb 2022, even if his place on the board will not expire till 2028. Will Biden give him another term? Surely, he’s done enough to support US economics, while putting far more emphasis on equality – but is it enough?

Richard Clarida’s future as Vice-chair is another consideration given his term on the board expires in Jan 2022. Either way, it's not a major consideration for now, but as we roll into the 2H21 questions will be asked about the future composition of the Fed.