Federal Reserve Gov. Lael Brainard said she expects policy to return “to a more neutral position later this year.”
Tech stocks and bond markets both sold off on Tuesday. Blame comments from Federal Reserve Gov. Lael Brainard.
In a Tuesday speech, Brainard said “it is of paramount importance to get inflation down,” and highlighted the urgency of tightening policy quickly. She also said the central bank will start to reduce the size of its balance sheet “at a rapid pace as soon as [its] May meeting.”
U.S. central bankers currently don’t plan to sell bonds from the Fed’s $8 trillion portfolio—they have assured investors they will allow bonds to mature without reinvesting the principal, much like they did in 2017. But on Tuesday, Brainard said she expects its bondholdings “to shrink considerably more rapidly than in the previous recovery.”
That sent long-dated Treasury yields sharply higher (and prices lower). The 10-year yield jumped 14.5 basis points, or hundredths of a percentage point, to 2.554% on Tuesday. The
30-year yield rose 10.9 basis points to 2.582%.
Brainard discussed the recent increase in long-dated Treasury yields as a sign of the Fed’s success in tightening policy. Those yields “tend to be most relevant for household and business decision-making,” she said, citing the increase in the cost of 30-year mortgages. The Fed’s bondholdings are seen as a way for it to directly influence long-dated Treasury yields: Its biggest holdings are in notes and bonds maturing in 2 years or longer. Its outlook for its interest-rate policy, on the other hand, affects short-dated yields most.
So Brainard’s comments about the Fed’s balance sheet hurt long-dated Treasury performance most, pushing those yields sharply higher. The
iShares 20+ Year Bond ETF
(TLT) dropped 2.3%.
Her comments also hurt stocks and other safe bond markets. The
was down 2.3%, the
Dow Jones Industrial Average
fell 0.8%, and the
declined 1.3%. The
iShares iBoxx $ Investment Grade Corporate Bond ETF
(LQD) fell 1.75%.
These markets all got hit because they have one thing in common: higher duration, or interest-rate sensitivity. Long-dated safe bonds post worse performance than shorter-dated or riskier bonds when rates go up. And the fast-growing tech companies in the Nasdaq perform worse than companies with steadier and slower-growing cash flows, because future earnings growth is worth less today when investors discount that growth at higher interest rates.
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Brainard also, in effect, confirmed a quick pace of rate increases this year, and said she expects policy to return “to a more neutral position later this year.”
Financial markets are now pricing in Fed rates above 2.2% by the end of 2022, Bloomberg data show. So investors see a growing likelihood of eight additional quarter-point rate hikes this year on top of March’s increase. (Seven additional rate increases were fully priced in on Monday.)
But the Fed’s pace of rate increases is already reflected in market prices. That means the main remaining uncertainty is whether its balance-sheet reduction will be quicker or slower than expected, and leaves the most risk in tech stocks and long-dated bond funds, thanks to their high duration.
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