The New Versus The Old Normal

Friday, the all-inclusive BLS employment report is issued. January’s data was the primary catalyst for February’s equity and Treasury swoon as wages unexpectedly accelerated.

Many times I have commented about the gargantuan change from “QE” to “QT.” How will such impact markets? A central bank has never attempted such a feat. It is not a question that if mistakes are to be made, but rather how significant these mistakes will be.

We are about six months into the Fed’s balance sheet normalization and its impact is now showing up in the data. The Fed allowed $10-$15 billion of assets to mature in both January and February. The previous three months, a total of $7 billion matured. Generally speaking, the Fed has reduced its holdings by approximately $30-$32 billion during the past five months, an amount that is expected to increase considerably over the coming quarters.

Yields across the Treasury spectrum have increased considerably over the past five months. Is the rise in yields the result of “QT” or from greater than expected economic activity? To write the obvious, dichotomies rarely occur. I think the rise in yields is the result of a number of factors with the greatest weighting on stronger than expected economic and wage growth.

What happens if costs push or wage inflation continues to accelerate above 3% as many of the PMI surveys suggest? Will the Treasury market begin to fear the unanchoring of “inflationary expectations,” amplified by the normalization of the Fed’s balance sheet via asset sales and maturities?

As discussed at length, the last 10 years was unprecedented with some stating that we have entered into the New Normal. For a myriad of reasons, I think the economy is now gravitating back to the Old Normal, a transition that will contain an infinite number of surprises.

The Old Normal is defined as more normalized balance sheet and growth closer to the 75-year average. As stated above, the equity and bond markets believe the New Normal will last into infinity. Yesterday, I referenced a Bloomberg article stating that bonds and equities are the most negatively correlation in 250 years, “an environment that is unlikely to persist.”

Commenting about yesterday’s market activity, equities were mixed as signs mounted the President could be dissuaded from enacting tariffs. Treasuries were flat.

Last night the foreign markets were mixed. London was up 0.05%, Paris was down 0.10% and Frankfurt was up 0.40%. China was down 0.55%, Japan was down 0.77% and Hang Sang was down 1.03%.