What Fed Chair Powell’s signal for accelerated tapering means for his confirmation

The Yahoo Finance Live panel breaks down Fed Chair Powell’s remarks on accelerated tapering.

Video transcript

JULIE HYMAN: Brian Cheung, I want to take it to you now because so much of the focus has been on Jay Powell and what he said yesterday and why he said it now. Walk us through why it was such a sort of big deal.

BRIAN CHEUNG: Yeah, well, I mean, it was a big deal because markets appeared to puke after we heard the commentary from the Federal Reserve chairman in his testimony to the Senate Banking Committee yesterday in the morning talking about the idea of maybe speeding up the tapering process. Again, that process of the Fed trying to bring to a full stop its $120 billion a month pace of asset purchases covering US Treasurys and also agency mortgage-backed securities.

Keep in mind that at the pace that they had set at their last FOMC meeting at the beginning of November that program was set to come to a full stop by the middle of next year, but there's some chatter now about the possibility of speeding that up, and he very much opened the door to that possibility happening as soon as the next meeting in about two weeks. Take a listen to what he told the Senate Banking Committee yesterday.

JEROME POWELL: At this point, the economy is very strong and inflationary pressures are high, and it is therefore appropriate, in my view, to consider wrapping up the taper of our asset purchases, which we actually announced at the November meeting, perhaps a few months sooner. And I expect that we will discuss that at our upcoming meeting in a couple of weeks. Of course, between now and then, we will see another labor-market report, another inflation report, and we'll also get a better sense of the new COVID variant as well before that-- before we make that decision.

BRIAN CHEUNG: And it was really interesting to see that the market action yesterday was your classic risk-off kind of behavior where you saw equities sell off and you also saw a commensurate decline in longer-term bond yields with the 10 year falling by as much as nine basis points to-- I think it was close to about 142 basis points on the 10 year.

But you also saw at the same time short-end yields rise quite a lot, actually. I think the two year rose to as much as about 60 basis points in response to those remarks, and that really has nothing to do with the actual tapering itself. There were some questions about whether or not you can call the reaction yesterday a taper tantrum. I think not because, really, that repricing on the two year more reflects whether or not speeding up the taper could also speed up hiking of interest rates in 2022.

But, of course, with the omicron variant, it's a bit unclear if bond markets are getting a little bit ahead of the Fed off of those remarks yesterday. I think this volatility that the markets are experiencing will likely continue to be the case not just through the Fed speak but also through the more research and science that we'll get out of this omicron variant, guys.

BRIAN SOZZI: Brian, do you think we learned yesterday how Powell got to keep his job, essentially perhaps telling President Biden-- who's been very focused, I think, on controlling inflation, wants to get it under control-- that in his new regime, he will be more focused on bringing down inflation? And then I think that's a very important potential takeaway here because, as an investor, you're looking at potentially four more years of Jerome Powell or maybe longer, whatever it is, that might be much different than the past four years or past couple of years.

BRIAN CHEUNG: Yeah, Brian, this is an absolutely critical point is that a lot of the commentary that you heard yesterday-- which, by the way, is not the Fed chairman saying we are going to announce a speeding up of our taper in December, merely that they're going to have a conversation about it. Of course, why bring it up at all if you're not going to seriously think about it, especially when you're trying to carefully piece together your communications as gingerly as the Federal Reserve tends to do?

But, of course, one big reason is because that hearing yesterday was not the Fed chairman's confirmation hearing. He was renominated by the president for a second term. As everyone recalls, that happened last Monday, which felt like eons ago, by the way. But when he does ultimately have his confirmation hearing, he's going to have to answer to a lot of specifically Republicans who are worried about these rising inflationary pressures, and he now has the tape to show, hey, I'm vigilant of these things. We're retiring the word transitory. We're going to be vigilant on inflation, which will likely just solidify the majority that he's already poised to secure in the 50-50 balanced Senate to get that confirmation.

So again, politics definitely playing into a little bit of this, although the data and the concerns that the Fed has over inflation do also kind of solidify the Federal Reserve's possible pivot here with regards to how they're approaching their policy normalization efforts. So that's definitely something to watch.

JULIE HYMAN: Hey, Brian, because of what you were talking about in terms of the movement of the short end of the curve versus the longer end of the curve, people are starting to watch the yield curve again. They always watch the yield curve, but it's been getting more chatter in the past 24 hours or so. In particular, people have been talking about the 5-30s spread narrowing, right?

Why do people pay attention to this? Well, it's another reflection of people's perceptions of future economic growth, and it also tends to presage a recession. But the one that is really the reliable predictor of that is 2 and 10s. This is something that Jim Reed of Deutsche Bank, among others, has talked about this morning.

And here it is, the 10-year Treasury versus the two-year Treasury. The shaded areas on this are recessions, and as you can see-- and you can see the zero line on the left or the zero mark on the left-hand side of this chart. And when it goes below zero, that's inversion. And as you can see, inversion tends to be the precursor to recessions, that signal, right?

So we're heading down in this yield curve or we're narrowing, to put it another way, but we're not at that zero point yet. But that is definitely-- as we get all of this taper talk and as we get talk about omicron, a lot of this, Brian Cheung, is sort of bubbling up into the conversation, it feels, like once again.

BRIAN CHEUNG: Yeah, and one big reason why everyone is so sensitive to the 2s and 10s is because it has a really incredible track record. In fact, in each of the last seven or now eight recessions dating back to 1969, an inversion where the 10-year yield is below the two-year yield has usually been followed by a recession within the 12- to roughly 18-month period after that. And, in fact, the last time that we got a yield-curve inversion was in August of 2019. We ended up getting a recession in 2020.

But I want to point out when you link those two things together, there is no mechanism by which the yield curve inverting in 2019 predicted that a global pandemic would be happening in 2020. So you want to call that coincidence. You want to call that whatever.

I think what the yield-curve inversion often tells you, though, at a more kind of reasonable interpretation is that markets are very sensitive. And I think that when you start to see the yield curve or the spread between the 2s and the 10s narrow like they are right now, you're seeing that sensitivity in markets. You're seeing the volatility. You're seeing the rising handle on the VIX, and I think that speaks to how very much these investors right now are worried about some other black-swan event, whether or not that's the "ohm-a-con," "ahm-a-cron," "o-mar-ion" variant, whatever you want to pronounce it as, or something else that could be coming down the pike.

So again, we're not inverted yet. That's not to say that this is going to be a recession coming again anytime soon. Deutsche Bank's Jim Reed just kind of merely pointing out, hey, this is an indicator of market sensitivity right now. It's not a call or any sort of base-case prediction for another recession, just merely that financial markets are getting a little bit nervous about what's going on.

JULIE HYMAN: Yes, and that is exactly the point also that I was trying to make yesterday when saying look at the reaction to omicron versus delta. Look at where that yield curve was in the summer versus now. So it's that background sort of delicacy or sensitivity, to use your word, in the market, and then you put these headlines on top of that.