Has the Market Lost Faith in the Fed?

Nothing will be answered during the sleepy summer months, but confidence in the Fed may be waning

   

Both the economic and earnings calendars were light on Monday, so the narrative is still a limited series of questions: When will the Fed taper, how much will it taper, who will be the next chairman, how much will interest rates rise and what effect will that have?

These questions are not likely to be answered anytime soon, as the Wall Street vacation season is now peaking. Sure, the hedge fund managers still trade from their dachas in the Hamptons, but they take more time off to swill champagne, play badminton with the kids and enjoy the sunshine before darkness starts to return in the fall.

Looking ahead, there’s not much news on the horizon either. We will get the Fed minutes from the July meeting this week, the flash PMI data, existing home sales and a couple of tech and retail earnings reports. Nothing much there is likely to move the dial.

In the meantime, the bond market is speaking loudest as Treasury yields continue to rise. The 10-Year is now yielding 2.88%, which is close to a full percentage point higher than the yield 3 months ago. That’s a lot of movement! Reports show that bond fund outflows have accelerated in reaction. For the month of August to date, U.S. bond mutual funds and ETFs have seen outflows of $19.7 billion. Compare that to $14.8 billion for all of July. At this pace, August’s outflow would be the fourth highest on record.

What does this mean? It’s actually very significant. The outflows support concerns that the Fed has lost control of the bond market. That’s not good because the market operates most fluidly when everyone believes that the Fed chairman is an Oz-like wizard. When markets lose faith in central banks, all manner of chaos can ensue. It’s a warning.

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