It was nice while it lasted but the “Rally in Everything” inspired by the dovish Federal Reserve is likely coming to an end — thanks to the dovish Federal Reserve.
U.S. bonds and stocks have climbed together for most of 2019 as expectations for Fed easing led yields lower and underpinned equities.
Chair Jerome Powell threw a wrench in the works last week by actually putting the central bank on a path toward cutting interest rates.
It may be counter-intuitive, but a likely rate cut this month means long-term Treasuries are vulnerable. That’s because what the central bank ultimately wants is faster inflation, which will eat into demand for long-duration assets.
St. Louis Fed President James Bullard, who showed foresight by voting for a reduction in June, summed it up by saying he would like “to make modest moves to try to re-center inflation and inflation expectations at our 2% target.”
The 10- year TIPS break-even rates, the bond market’s measure of inflation expectations, are starting to reverse a two-month decline. Up to about 1.77% Friday from 1.62% in mid-June, they still have a way to go to get to 2%.
The June CPI report last week also seemed to vindicate Powell’s earlier assessment that some of the recent slowdown in inflation was transitory — the core rate of 2.1% matched the highest this year.
The Fed will likely be easing at a time when the broader economy, though slowing, is still chugging along. As Atlanta Fed President Raphael Bostic said “the aggregate numbers look pretty good.”
Long bonds, those most sensitive to inflation, are already suffering. A 30-year Treasury sale last week was a flop and yields rose to the highest since May. Meanwhile, the S&P 500 and Dow Jones Industrial Average both set record highs last week.
Stocks and bonds are beginning to move out of sync — look for the decoupling to continue.