Jay Powell's debut testimony to Congress unnerved investors with a hawkish tone, sending the S&P 500 1.3% lower and pushing yields slightly higher. The new Fed chair indicated that "some headwinds facing the US economy are now tailwinds" and cautioned that the central bank would be keen to avoid "an overheated economy," especially given the recent fiscal stimulus from Congress.
But we believe that the Fed is likely to remain on a gradual tightening path, which will avoid putting significant upward pressure on bond yields or undermining equity markets.
- Bond investors had already braced for a moderate increase in the pace of rate rises. The yield on the 10-year Treasury, which has climbed around 80 basis points over the past five months, rose only fractionally on the testimony. Futures contracts priced in only four additional basis points of tightening in the course of 2018.
- 10-year bonds still look attractive. With carry and roll down returns of around 1.6% over cash this year, yields would need to rise by around 20 basis points to erase gains from holding 10-year bonds.
- The latest economic releases have been relatively balanced. Soft data has been hard and hard data has been softer. While US consumer confidence hit the highest level since 2000, US durable goods orders in January fell 3.7%, the largest drop in six months.
So we remain overweight US 10-year Treasuries versus cash. We are also overweight global equities. Attention will now shift to tomorrow's release of the Fed's favorite inflation measure, the Personal Consumption Expenditure Index for January, which is expected to remain steady at 1.5% year-over-year.
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