CNBC/Eric Rosenbaum
Why the market’s manic moves over the Fed and inflation may not peak until summer

Last week’s market action was one more example of a push and pull between stocks, bonds and the Federal Reserve which investors should expect to see more of throughout 2021. In fact, there’s reason to believe the battle over bond yields and inflation which has gripped stock investors may not peak until the summer.

The Dow Jones Industrial Average hit another new record last week — and Dow futures were strong on Sunday — as some of the sectors favored in a rotation away from growth gained, including financial and industrials, and gained further support from the new round of federal stimulus, while the latest inflation number came in below estimates. The Nasdaq rebounded sharply and beaten-up, big 2020 success stories like Tesla rallied. But investors looking for an all-clear signal to be sounded didn’t get one as tech sold off to end the week with 10-year Treasury bond yields hitting a one-year high on Friday.

The Fed meeting on Tuesday and Wednesday of this week may drive action in yields and growth stocks, but with Fed chairman Jerome Powell expected to maintain his dovish stance, some bond and stock market experts are looking a little further out, to the May-July period, as a key one for investors. An important data point informs that view: inflation is expected to hit a one-year peak in May, and it will mark a dramatic rise.

Year over year gains in the Consumer Price Index (CPI) will peak in May at 3.7% for the headline number and 2.3% for core inflation, according to a forecast from Action Economics. That should not be a surprise. As the U.S. marks its one-year anniversary from the start of the pandemic, it is the May-to-May comparison which captures the shutdowns which gripped the country last spring and now will serve to magnify this May’s inflation print.

But even seeing this coming, the steep climb in inflation over the coming months will likely add to investor concerns that the Fed still may be under-appreciating upside inflation risks. It is just a matter of time before the economy is fully opened and economic expansion occurs at a rate which will drag inflation and interest rates higher.

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CNN Business/Julia Horowitz
Jerome Powell can’t take his eyes off the job market

Federal Reserve Chair Jerome Powell has made it very clear that unlike some investors, he’s not stressed out about a potential rise in inflation later this year. And there’s good reason for that: he’s busy worrying about jobs.

What’s happening: The US economy is still down 9.5 million positions since February 2020, putting huge pressure on the central bank to keep stimulus coming for the foreseeable future. Expect Powell to hit this point hard when the Fed announces its latest policy decision this week.

The central bank is tasked with maintaining both stable prices and maximum employment. Last summer, it tweaked its strategy, indicating that policymakers would allow inflation to climb above its 2% target if necessary.

That gives the Fed a lot more leeway to keep interest rates lower for longer — and that’s what many economists expect it to do.

“They’ve said they’re willing to be patient,” Joseph Brusuelas, chief economist at RSM US, told me.

The passage of President Joe Biden’s $1.9 trillion relief package could help. Airlines said last week that they were canceling furloughs, and supplementary unemployment benefits and stimulus checks are expected to boost demand, supporting employment in struggling industries.

Some experts, including former Treasury Secretary Larry Summers, have warned that the package could send prices higher. But Brusuelas thinks there’s just too much slack in the labor market for sustained inflation to materialize — especially given how much one-time spending the bill contains.

“It’s simply not going to happen on the back of this particular legislation,” he said.

The package won’t eliminate economic scarring. Many jobs in the hospitality, entertainment and retail sectors won’t ever return. Researchers at Harvard University have found that the number of small businesses open is still down 32% compared to January 2020. The Economic Policy Institute, looking at the latest report on job openings from the Bureau of Labor Statistics, notes that for every 15 unemployed workers, there were only available jobs for 10 of them.

“That bartender is going to have to learn how to code. That waitress is going to have to become digitally literate, because their jobs are likely not going to be there in the early post-pandemic economy,” Brusuelas said.

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Marketwatch/Sunny Oh
Markets set up for disappointment from Fed meeting as bond yields renew rise

All eyes will be on the Federal Reserve’s meeting next week as traders put pressure on the central bank to prevent a de-stabilizing rise in bond yields.

Yet the U.S. central bank is likely to stick to its messaging that higher yields reflect the rosier economic outlook, suggesting the clash between recalcitrant bond traders and a patient central bank will continue.

“The Fed is aiming for higher inflation which means higher interest rates. I think the market has misread the Fed in thinking about yield curve control,” said Steven Ricchiuto, chief U.S. economist for Mizuho, in e-mailed comments.

The central bank’s unwillingness to push back against the bond market’s speculation has ended up sapping investor sentiment, with the sharp rise in long-term bond yields this year causing momentary panic across technology stocks, corporate bonds and emerging markets.

Some of these market nerves reflect worries that a further disorderly increase in long-term yields could hamstring a recovering and highly leveraged economy, ill-prepared to deal with a rise in borrowing costs.

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