The market is getting nervous this week over Powell’s testimony

Rising bond yields and the accompanying fears of inflation add a level of drama to Federal Reserve Chairman Jerome Powell’s performance before Congress this week.

The central bank chairman is scheduled to address Senate and House panels on consecutive days as part of mandatory biannual monetary policy updates.

Normally routine affairs, the recent turmoil in the financial markets and concerns about how the Fed might respond have made investors pay more attention than usual to the Tuesday and Wednesday hearings.

“This is one of the more interesting episodes in which a Fed chairman has had to testify,” said Nathan Sheets, chief economist at PGIM Fixed Income. ‘Sometimes we say’ ho hum, no news’. This will be news. He is really stuck between a rock and a hard place. ‘

What recently caught the market’s attention was a rise in government bond yields, particularly further down the curve.

While the 2-year year is unchanged for 2021, the 5-year is up nearly a quarter of a percentage point from Friday’s market close, while the return on the 10-year benchmark is up 41 basis points to 1.34%, an area where the Not since about the same time in 2020, before the worst pandemic struck.

The yield on 30-year bonds has risen even more, rising nearly half a point to 2.14% this year.

Powell’s dilemma is this: Rising bond yields could signal the reflation of the economy that has fueled the Fed and are therefore higher for good reasons. However, should the trend get out of hand, the Fed may need to tighten policies faster than the market expects, offsetting some of the good that has accompanied the explosive interest rates.

Complicating the matter is that the markets may also not like it when Powell is overly complacent.

“If this testimony took place behind closed doors, I think Jay Powell would be quite pleased with what he sees in the economy and the markets,” said Sheets, the nickname of the Fed chairman. “But given that it’s public, he has to be careful. If he’s too optimistic about interest rates hike, markets will see that as an important green light for higher interest rates.”

“The Fed is pleased with an organic rate hike as a result of shifts in the view of growth and inflation,” he added. “But I think the Fed also wants to be careful not to create and strengthen self-sustaining dynamics that drive up interest rates for other reasons.”

Those “other reasons” are primarily the fear of the economy overheating.

The Fed has pursued a historically loose policy over the past year, cutting its benchmark rate to near zero and buying at least $ 120 billion in bonds each month. That’s in addition to a series of now-expired credit and liquidity programs implemented in the early days of the Covid-19 crisis.

In addition, Congress has received more than $ 3 trillion in fiscal stimulus and could approve up to $ 1.9 trillion more by the end of the week.

All of that has happened in an economy that’s humming, aside from a still worrying employment problem, especially in the services sector. Wall Street addresses first quarter growth expectations and market-based inflation indicators are on the rise.

That’s why Powell’s tightrope walk this week will be all the more compelling.

“The mood in the market has changed,” Mohamed El-Erian, chief economics adviser at Allianz, told CNBC’s “Squawk Box on Monday.” It is no longer when the yields get higher, it is when the move is too big. That’s what the market is trying to find out. “

Investors are particularly concerned that all stimulus measures will not go overboard and risk destabilizing the economy in the longer term.

“I can predict that the yellow lights will blink all over the Fed because of the [yields] movement and the steeper yield curve, and the Fed could do more to keep interest rates under control, ”said El-Erian.

Fed officials have largely rejected so-called yield curve control to use the purchasing power of bonds to control interest rates between different fixed-rate maturities.

But the market could force the Fed’s hand, and Powell will likely be asked where he stands and what tools the Fed has to calm down market troubles. He has repeatedly emphasized that the Fed has the weapons to control inflation, but using it comes at a price. Markets accustomed to low yields and companies accustomed to cheap financing costs could be confused by an unexpected move by the Fed.

Evidence of how clearly the market is looking at the issue came Monday morning, when European Central Bank president Christine Lagarde said she is “closely monitoring long-term nominal long-term yields”. Her words were enough to calm a nervous market and turn what had been an opening loss on Wall Street into a mixed market with the Dow in the early afternoon trade. Treasury yields were virtually flat on the day.

Tom Lee, managing partner and head of research at Fundstrat Global Advisors, noted that his “clients have already expressed some concerns about this week. Part of this reflects the fact that bond yields have been steadily rising and equity investors are nervous about the bond market. Powell’s testimony is reaching some sort of ‘breaking point’

Powell will speak before the Senate Finance Committee on Tuesday and before the House Financial Services Committee on Wednesday.