Mid-week market update: I told you so. Earlier in the week, I wrote that the market had become overly hawkish about interest rate expectations (see Hawkish expectations). Leading up to the November FOMC meeting, the Fed had signaled that a QE taper is about to begin and, if everything goes along with projections, the first rate hike would occur in late 2022.
The Fed doesn’t want to drop the new framework at the first sign of trouble. The issue of full employment still obstructs the path to rate hikes. If the Fed were to pull tapering forward, the implication would be either the Fed is abandoning its new shiny new framework or that it has redefined full employment. Remember, there is institutional inertia at play here…The new framework sets the Fed apart from its central banking peers that are quickly pivoting in a hawkish direction. Indeed, the new framework is intended to prevent such a pivot, which means that if the Fed were to move in the BoC/BoE/RBA/RBNZ direction, it would amount to abandoning the new framework.
We got a dovish taper, which is what I expected. The 2-year Treasury yield eased in reaction to the FOMC decision and the yield curve steepened.
As well, ECB head Christine Lagarde said today that conditions for rate hikes are unlikely to be met next year. As a consequence, German 2-year rates also fell.
Rising bond yields
Small caps break out
Year-end rally underway