Bond yields have dropped sharply in the past week, and swaps are now implying a lower terminal rate than the median projection of Federal Reserve Board members and Federal Reserve Bank presidents. Meanwhile, the S&P 500 Index rose for the third consecutive day on Wednesday before giving up its gains at the close.
Federal Reserve Chair Jerome Powell believes that monetary policy is carried out through financial conditions, and for the time being, he seems to like where they stand. As he told lawmakers Wednesday, “the market has been reading our reaction function reasonably well.”
That markets and the Fed are on the same page is good news for near-term volatility, but Powell’s words also contain a veiled threat: If financial assets recover too far from the recent selloff, he has ways of putting them back in their place. Investors adjust Powell’s dial at their own peril.
