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June 21, 2021, 9:17 a.m. EDT

Markets are sending ‘peculiar’ signals as Fed changes tune — here’s what they mean

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By William Watts

Financial markets went a little wild in the past week, after the Federal Reserve on Wednesday delivered an unexpected message.

Policy makers penciled in two interest rate increases by the end of 2023 and began talking about the eventual need to slow down the central bank’s monthly asset purchases.

Read: Barclays moves up expectations for Fed tapering after FOMC meeting

But a reading of the reaction across financial markets may be signaling that investors don’t think the Federal Reserve will have room to raise rates very far once the hiking cycle begins, argued George Saravelos, currency strategist at Deutsche Bank, in a Friday note.

But first, how wild was Thursday’s session?

  • The ICE U.S. Dollar Index DXY saw its biggest one-day jump since the March 2020 pandemic forced a global scramble for greenbacks as the economy shut down.

  • Long-term Treasury yields tumbled to their lowest levels since February as investors snapped up the maturities

  • Commodities tanked, with some witnessing their biggest one-day drops since March 2020.

  • The tech-heavy Nasdaq Composite /zigman2/quotes/210598365/realtime COMP +0.70% rallied as other benchmarks flagged, ending just shy of a record. The Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA -0.36% sank, while the S&P 500 /zigman2/quotes/210599714/realtime SPX -0.02% suffered a fractional loss.

Short-term yields continued to rise along with the dollar on Friday, while commodities saw a mixed performance and stocks extended losses into the closing bell, albeit with the Nasdaq modestly outperforming its peers.

Saravelos sought to tie it all together.

Dollar rally

Among the individual moves, the dollar rally was the easiest to explain. The move, he wrote, “was entirely consistent with our framework that what matters for the greenback is front-end real rates.” Real rates are yields adjusted for inflation. The short end of the yield curve rose sharply in reaction to the Fed’s shift, while longer maturities fell.

“There should be no surprise that the dollar has rallied strongly even if 10-year yields have not made new highs,” the economist said.

Read: Why the U.S. dollar is soaring — and what’s next — after Fed’s change in tone

Commodity selloff

“The role the Fed has played in inflating commodity prices should not be underestimated,” Saravelos said, noting a “very high” inverse correlation between the dollar and base metal prices. In other words, when the dollar falls, prices rise, and vice versa.

/zigman2/quotes/210598365/realtime
US : Nasdaq
14,762.58
+102.01 +0.70%
Volume: 3.80M
July 28, 2021 5:16p
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/zigman2/quotes/210598065/realtime
US : Dow Jones Global
34,930.93
-127.59 -0.36%
Volume: 347.17M
July 28, 2021 4:55p
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/zigman2/quotes/210599714/realtime
US : S&P US
4,400.64
-0.82 -0.02%
Volume: 2.09B
July 28, 2021 4:55p
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