Fed-Induced Volatility Surge

The Dow and S&P 500 fell in early trading, giving up all of yesterday’s rally. Technology, financials and communications sectors are leading to the downside. The VIX Index jumped back to 30, indicating higher expected volatility over the next month. Commodities are mixed today. Gold, copper, iron ore and agricultural goods are retreating whereas WTI crude oil is back up around $108/barrel. OPEC decided on a small increase in oil production, not enough to dent the supply deficit resulting from global sanctions on Russia. The bond market is trading broadly lower, with most of the damage in long-term issues. The iShares 20+ Year Treasury Bond Fund (TLT) is down 3%. The closely watched 10-year Treasury Note yield climbed to 3.08% (highest since Nov. 2018)

As expected, the Federal Reserve raised its policy interest rate by .5% to a range of .75% to 1%. Yesterday’s announcement said “ongoing increases will be appropriate” in order to contain inflation. This was slightly different and perhaps less aggressive language than we’ve heard from the Fed in the recent past. In addition, during the subsequent press conference Fed Chair Powell confirmed that his policy committee isn’t “actively considering” rate hikes larger than .75%. Further, guidance on the Fed plan to reduce its balance was in line with what investors expected to hear. Beginning in June the Fed will shed $47bil of bonds per month, with the pace quickening to $95bil in September. In short, Mr. Powell indicated that the Fed won’t back down from inflation, but neither does it intend to tighten financial conditions beyond what has already been discussed. Both stock and bond markets rallied on the news. The S&P 500 ended the day up 3% and the 2-year Treasury Note yield fell .15% to 2.63%.

But that positive reaction has obviously reversed today. And I guess I should point out that Fed announcements are typically followed by volatile swings in both stock and bond markets. So this type of price action isn’t unprecedented. In this instance, my guess is that stocks are following moves in the bond market. That is, stock traders (not investors) were spooked by the long bond selloff. We know that short-term yields are more influenced by Fed policy, and they’re relatively calm today. But longer-term bond yields reflect expectations for economic growth and inflation. I think most market participants believe long yields need to go higher. Inflation will likely be elevated for a quite a while, but so might economic growth. I know most of the headlines today will paint the bond market selloff in negative tones, but the simple truth staring us in the face is that if bond traders expected a recession sometime within the next year, long-term bond yields would be falling, not rising. I know this terminology is all very wonky, so let me put it another way. Don’t you think that if the economy was about to fall apart you’d see investors flocking into safe-haven Treasury bonds? Well, we’re not seeing that.

So what should we do? Ritholtz Wealth CEO Josh Brown cautions investors not to “allow your emotions to swing back and forth—despondency one day, euphoria the next day. You have no control over what is happening in the market. The only thing you can control is how you’re going to react to it, or not react to it. This is the essence of managing money. It’s about temperament. Temperament is a super power as an investor. On a day like today, this is most important thing to keep front of mind.”