Market Volatility Rises – Markets Shoot First And Ask Questions Later

They say life can change at “the drop of a hat.” Markets too!

Interest rates had gapped significantly higher Monday, Tuesday, and Wednesday of Thanksgiving week only to plunge back to even lower levels by Friday’s close (November 26) based on the fear that the newly identified Covid-19 variant (omicron) could, like its delta-variant sister, once again disrupt the world.

Friday, after Thanksgiving, has always been a shortened market day with most senior market participants on the sidelines. Junior traders often have the green light to sell, but not to buy, perhaps partially the reason that, on Friday, the major equity indexes also tumbled more than 2%. What happens Monday depends on updates regarding omicron, but it is clear that over the near-term horizon, both the equity and fixed income markets are going to display a level of volatility that we haven’t seen for the past 18 months. Still, we can’t simply dismiss the Monday, Tuesday, and Wednesday interest rate spike as if it never happened.

The Yield Curve

Apparently, bond investors expected President Biden to appoint Lael Brainard as Federal Reserve Chair. Ms. Brainard is considered quite “dovish” (i.e., would keep monetary policy ultra-easy). Powell’s reappointment appeared to partially ignite the yield curve upward spike with the end result being that three 25 basis point (.25 percentage points) increases in the Federal Funds rate (what banks pay to borrow from the Federal Reserve), beginning in mid-2022, got priced in. That was quite a change from the prior Friday view that there would only be one rate hike in late 2022.

• To characterize Powell as a “hawk” seems like a stretch. Over the last few months, he has resisted any forecasts of rate increases insisting that such increases are data dependent (i.e., based on the performance of the economy). 
• Powell has set Q2 or Q3/2022 for the Fed’s evaluation of inflation. That is, the Fed expects the “transient” period to be as long as another year. In Fedspeak, that should signal no rate action till at least Q3 if inflation is still elevated (hardly “hawkish”).
• Brainard was appointed as Vice-Chair and Biden has three more FOMC vacancies to fill. Given his Administration’s policy actions to date, we expect those seats to be filled by people with a dovish bent. 
• In our view, markets were making unwarranted assumptions (i.e., Shoot first!).

The Labor Market

Also impacting the bond market on Wednesday was the Weekly Initial Unemployment Claims (ICs) data for the week of November 20. It showed a modern-day record low of 199,000 ICs seasonally adjusted (SA). As we have opined for the past 18 months, trying to seasonally adjust the impacts of a pandemic (that has been around for less than two years) is troublesome and could lead to unwarranted conclusions. 

The table below shows ICs for the…