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The Fed’s Inflation Expectation is anchored around 2%, but Traders aren’t buying it

2018-04-26T17:31:31-04:00 Mar. 19, 2018 9:00AM EDT|

The truth is that the Facebook debacle was a paper bag over the real news, which most traders are trying to keep pace with. Most traders understand that throughout the Bull Run, over the last 5 to 8 years, the Tech Stocks, along with Consumer Discretionary and the Infrastructure play that was completely restructured, has defined the market, due to Quantitative Easing tailwinds.

However, there still remains obvious nervousness in the markets, due to Central Bank rate hikes and the potential Quantitative Tightening headwinds. The buzz among front line traders on the exchange floor is that the new Fed chairman, Jerome Powell, just like his predecessor, Janet Yellen, has yet to provide clarity about what are acceptable inflation levels and where does the Fed become interest rate hawks; or how high is too high and how low is too low? To which Powell responded that “the fed is looking for symmetry and some consistency in the standard deviation above or below 2%”.

Traders are just not buying what the Fed is selling and, according to Deutsche Bank, global Central Banks are delivering interest-rate increases at the fastest pace since 2011.

The Federal Reserve raised its bench mark Fed Funds rate by 25 basis points and said that they plan to continue with their original policy of gradually increasing the interest rates and will continue to monitor inflation which they believe will hover around 2%. Inflation usually is based on job rates, productivity ratios and the Core CPI. However, floor traders argued that they plan to keep abreast of these economic numbers before the next Fed rate hike and carefully monitor Retail Sales which is a key avenue of consumer spending and makes a major contribution to the labor market. This sector has undergone some changes due to internet sales which have affected total sales, revenues from different store types, and employment.

What does this mean for the bond Market?

For us to understand this we must first understand what a yield curve is, it is graphed line that represents the relationship between short-and long-term interest rates.

Typically, short term rates are determined by the Federal Reserve and long term rates are market driven, with long term rates usually running higher since they factor in the Risk Premium for longer term maturities. We are now seeing the yield curve flattening.

The best bet for investors in today’s market, who are still looking for an investment in income producing instruments, despite the current dynamics, is to be in short to medium term vehicles, because their returns are the same as long term bonds, but the shorter terms reduce their risk exposure.

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