Analysis: Fans of Powell’s 'higher for the longer term’ mantra investors wary of economy

NEW YORK, Aug 25 (Reuters) – Federal Reserve Chairman Jerome Powell on Friday did little to dissuade markets from the „long-term high” rate hike that has pushed Treasury yields higher in recent weeks. The economy may not survive next year’s recession.

Speaking at the Kansas City Fed’s annual meeting in Jackson Hole, Wyoming, Powell emphasized the surprising strength of the U.S. economy despite acknowledging a decline in the pace of inflation last year, leaving open the possibility of further rate hikes.

Although more balanced than the Fed chair’s ultra-hawkish speech at last year’s symposium in Jackson Hole, the speech offered little comfort to those who believe the Fed will eventually head toward rate cuts in 2024.

For some investors, the view reinforced concerns that higher yields could eventually weigh on the economy’s strong growth and bring about a potential downturn, although most believe the US could avoid a recession in 2023.

„There’s a recession risk for 2024, and we want to … make sure we’re in corporate debt that’s well-positioned to weather the downturn,” said Cindy Beaulieu, managing director and portfolio manager at Canning, which manages $205. billion.

„Those types of trades are critical now as opposed to trying to take on additional credit risk,” he said.

Financial markets on Friday saw little of the volatility that accompanied last year’s Jackson Hole confab, when stocks fell more than 3.4%.

Yields on the benchmark 10-year Treasury, which moves inversely to bond prices, were around 4.239% on the day, despite hitting a 16-year high earlier this month. Two-year yields — which are more closely tied to monetary policy expectations — added three basis points.

Stocks — which faltered in August as rising bond yields threatened to dull the appeal of equities — were little changed with the S&P 500 up 0.22%. Options markets priced in a move of about 0.9% in the index ahead of the meeting.

A surge in bond yields in the past few months — driven by bets that the central bank will keep rates at current levels longer than expected to curb inflation — has pushed 30-year mortgage rates higher in the economy. Credit spreads, the highest level in more than 20 years, widened slightly this month, a measure of risk.

Investors said the next few weeks will depend on what the data shows. The US will report labor market data for August on September 1 and consumer price data on September 13.

„It looks like Powell is buying time and waiting for more data to come in so they can set themselves up to continue the soft landing path,” said Anders Persson, chief investment officer of global fixed income at Nuveen.

Recession concerns are reviving

Some investors worried that higher rates could weigh on growth and increase the chances of a recession next year. Such a scenario would, in theory, force the central bank to cut rates, driving down bond yields.

„There is little chance of a soft landing after today,” said D. Mike Sewell, portfolio manager at Rowe Price, said he expects to add to long-dated bonds in the fourth quarter as the U.S. economy begins to weaken.

„We are waiting for the financial conditions to crack,” he said.

Fed fund futures traders were pricing in a total of 100 basis points of rate cuts next year, unchanged from bets before Powell’s speech, but pushing the first rate cut from May to June.

Of course, betting against the US economy is a risky venture this year. Several banks have reversed calls for a 2023 recession in recent months, while challenges to an economic slowdown have helped fuel the S&P 500’s 15% rally in the year to date.

At the same time, many investors believe that yields will remain elevated for the time being.

Hedge funds’ bearish bets on long-dated U.S. Treasuries were at their highest for several weeks, according to last week’s Commodity Futures Trading Commission data.

„The market is very narrow,” said Josh Emanuel, chief investment officer at investment management firm Wilshire.

But he preferred to extend the duration of his portfolio, despite the risks that could increase long-term bond returns. „We remain technically neutral today, but increasingly bullish on longer-term Treasuries.”

Our Standards: Thomson Reuters Trust Principles.