Lack of Market Reaction to Yellen Embracing Higher Rates Speaks Volumes

Janet Yellen delivering a speech
Credit: Jonathan Ernst - Reuters /

For me, today started with some confusion. My early morning usually follows a pattern. I first check Treasury yields, then the futures of the major indices, the S&P 500, Dow, and Nasdaq, and then other market indicators such as gold, the dollar and crude oil. The final part of my early morning routine is to turn to the news stories, to see what might be causing any moves I see in markets.

Over the last six months or so, one thing in the news that has been pretty much guaranteed to drive stocks lower is anything that may even hint at rate hikes. That could be data that point to an inflationary environment, or it could be a comment from someone in power that seems innocent enough on the surface, but if parsed sufficiently will trigger a nervous bout of selling from traders. They are all too aware that massive gains in stocks have been fueled by ultra-low interest rates, and that equities are vulnerable as they hit yet more record highs, so any suggestion of a hike causes a hissy fit.

So, imagine my surprise this morning when one such comment looked to be being completely ignored.

On Sunday, in in an interview with Bloomberg, Treasury Secretary Janet Yellen said that higher rates would be a “plus” for America and for the Fed. That looks a lot like someone who should have a fairly good idea of how the Fed is thinking, both as Treasury Secretary and as a former Chair of the Federal Reserve, preparing traders for a rate hike.  And yet, this was the reaction in the E-Mini S&P 500 futures (ES):

ES futures chart

Just before the market open, they were trading right around the weekend close. There was a sharp dip early this morning, but a rapid recovery and then a move higher as the morning progressed. In other words, there was really no reaction at all.

That seems to make no sense based on the headline, but if you dig a little deeper into the interview, there is a reason for it. Yellen’s reason for showing such unusual and previously uncharacteristic enthusiasm for inflation and a rate hike is that they are possible results of something else that she supports: continued fiscal stimulus from her boss’s $4 trillion infrastructure plan.

The market’s failure to freak out over the comments suggests that traders and investors believe that the proposed stimulus is likely to happen in some form or another, and that it will be enough to offset the negative impact of rate hikes.

That has some serious implications. If the market is now focused on fiscal stimulus and able to take talk of rate hikes in its stride, the progress of Biden’s infrastructure plans becomes the most important thing to watch over the coming weeks. Normally, that would suggest some aggressive buying because the one thing that politicians of all stripes can usually agree on is that massive spending in their districts in the name of infrastructure is a good idea. It is easy to defend when the end result is improved roads and bridges, and better internet coverage around the country, and a host of jobs. For those purposes, budget-busting spending can be cast as investments in the economy, and that ensures political support for measures that, coincidentally, also result in happy voters.

However, these are not normal times in any way, and particularly not politically. Republicans have made it clear since early in Obama’s first term that their only priority with a Democrat in the White House is obstruction, and Democrats, all too aware that history suggests that their majority in both chambers of Congress will probably disappear at the next election, are pushing hard to add all sorts of left-wing legislative priorities to an “infrastructure” bill.

Those things make the normally uncontroversial practice of passing an infrastructure bill look like an uphill task.

So, we have gone from a situation where traders fear a rate hike that is unlikely in the near future and that can be delayed for years by the Fed if they choose, to fear of a failure to significantly increase fiscal stimulus, an outcome that looks quite likely. That is good news for traders, but not for investors. It doesn’t mean that we are about to collapse, but it does make it likely that as the horse trading of politics progresses, there will be some serious volatility in the stock market, with every dispute that puts an agreement in danger triggering a selloff and every hint of harmony prompting a run up.

Buckle up for a bumpy ride!  

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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