(Bloomberg) — Jerome Powell did what was widely expected in his Jackson Hole address, renewing the Federal Reserve’s aggressive vows. Now that the dust has settled, here are four views on the direction of key assets in the coming months:
- Stocks have more short-term price drop (next two weeks)
- The Cboe Volatility Index () should remain supported
- Short-term yields should remain higher, but long-term yields remain relatively subdued. The real yield curve should continue to flatten quite aggressively
- The dollar’s rally should disappear soon
Powell’s speech sparked a surge in short-term real yields. The real peak Fed Funds has a very close relationship with the . The Fed Funds’ true peak has risen lately — including another 21 basis points on Friday with Powell’s speech — but the S&P 500 has lagged the move so far, suggesting more stock prices on the way.
However, equity positioning generally remains very short, increasing the risk of a squeeze. Sentiment has improved, while internal factors such as the forward decline line, the net number of stocks hitting new 52-week highs and the number trading above their 200-day moving average are constructive.
Nevertheless, we remain in a bear market and the net gamut is now negative, meaning greater potential for more near-term downside follow-up.
So volatility should remain supported. The VIX stood out as an attractive Jackson Hole hedge and has since risen, better than expected move based on the decline in the S&P 500.
Short-term yields are likely to continue to experience upward pressure, but as long as the momentum continues that this is a rise in inflation, which can be easily resolved by some fairly modest rate hikes, long-term yields will “under-reflect” the rise in rates.
The decline in the term premium in recent months embodies this dynamic. Inflation volatility is very high, which would normally require a higher term premium from bondholders. That it is falling means there is a strong belief – misplaced in my view – that inflation will soon return to a low and stable regime.
As long as the term premium remains limited, the flattening pressure on the nominal yield curve will continue. However, the real yield curve should continue to flatten more aggressively as the Fed maintains its aggressive stance and inflation (cyclically) begins to decline.
The flatter yield curve points to the growing unattractiveness of real yields to foreign buyers of government bonds, which will be a reinforcing headwind for the dollar. The Japanese – who are the largest holders of USTs – have been noticeably absent from the market this year. This isn’t much of a surprise given that a Japan-based buyer of 10-year USTs hedging the currency is losing about 125 basis points per year versus buying a 10-year Japanese government bond.
Once Jackson Hole’s knee-jerk reaction is out of the way, resistance to the dollar — in the absence of a global financial shock or acute risk meltdown — is likely to increase as an aggressive Fed continues to put pressure on the economy. real yield curve.
- NOTE: Simon White writes for Bloomberg’s Markets Live blog. The observations he makes are his own and are not intended as investment advice. See the MLIV blog for more market commentary
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