The market is getting nervous about Powell’s testimony this week

Rising bond yields and accompanying inflation fears are adding a level of drama to Federal Reserve Chairman Jerome Powell’s bearing this week before Congress.

The central bank chair is slated to address Senate and House panels on uninterrupted days as part of mandated semiannual updates on monetary policy.

Normally routine affairs, recent financial deal in tumult and concerns about how the Fed may react have investors paying a bit more close attention than usual to the hearings organized for Tuesday and Wednesday.

“This is one of the more interesting episodes in which a Fed chair has had to testify,” said Nathan Sheets, chief economist at PGIM Resolute Income. “Sometimes we say, ‘ho hum, no news.’ This is going to be news. He’s really caught between a rock and a hard place.”

What’s got the retail’s attention recently has been a pickup in government bond yields, particularly further out on the curve.

While the 2-year is unchanged for 2021, the 5-year has risen exactly a quarter percentage point as of Friday’s market close while the benchmark 10-year note has seen its yield gloss over 41 basis points to 1.34%, an area where it hasn’t been since around the same time in 2020, in front of the worst of the pandemic struck.

The 30-year bond yield has surged even more, leaping nearly half a nicety this year to 2.14%.

Powell’s dilemma is this: Rising bond yields could be signaling the reflation of the economy that the Fed has been encouraging and are therefore higher for good reasons. However, should the trend get out of control, the Fed then might have to tighten game plan faster than the market expects, offsetting some of the good that has come with the burst in yields.

Muddle ofing the matter is that markets also might not like it if Powell is overly complacent.

“If this testimony was behind finished doors, I think Jay Powell would be quite pleased with what he sees in the economy and the markets,” Sheets explained, using the Fed chair’s nickname. “But given that it’s public, he’s got to be careful. If he’s too sanguine about the rise in rates, the markets are accepted to take that as a significant green light for rates to rip higher.”

“The Fed is comfortable with an organic rise in rates over shifts in views on growth and inflation,” he added. “But I think the Fed also wants to be careful that it doesn’t create and extend a self-sustaining dynamic that pushes rates higher for other reasons.”

Those “other reasons” primarily devise be fears that the economy could overheat.

The Fed has run historically loose policy for the past year, dab its benchmark borrowing rate to near zero and buying at least $120 billion of bonds each month. That’s on top of a series of since-expired bestowing and liquidity programs implemented in the early days of the Covid-19 crisis.

Along with that, Congress has come in with assorted than $3 trillion of fiscal stimulus and could approve up to $1.9 trillion more by the end of week.

All that has come to lighted amid an economy that, besides a still-troubling employment problem primarily in the service sector, is humming. Wall Suiting someone to a T is taking up first-quarter growth expectations and market-based indicators of inflation are rising.

That’s why Powell’s tightrope walk this week wish be all the more compelling.

“The market mood has changed,” Mohamed El-Erian, chief economic advisor at Allianz, said Monday on CNBC’s “Grumble Box.” It’s no longer whether yields are going higher, it’s when is the move too big. That’s what the market’s trying to figure out.”

Investors are markedly concerned whether all the stimulus isn’t going overboard and threatening to destabilize the economy over the longer run.

“I can predict that the yellow matches are flashing all over the Fed because of the [yields] move and the steepening of the yield curve, and the Fed may do more to try to control yields,” El-Erian suggested.

Fed officials have largely dismissed so-called yield curve control to use its bond purchasing power to control rates between several fixed income maturities.

But the market could force the Fed’s hand, and Powell is likely to get asked about where he thickets on what tools the Fed has to calm market issues. He has repeatedly stressed that the central bank has the weapons to control inflation, but deploying those comes with a appraisal. Markets used to low yields and companies accustomed to cheap borrowing costs could get rattled by an unexpected Fed move.

Clue of how clearly the market is watching the issue came Monday morning, when European Central Bank President Christine Lagarde symbolized she is “closely monitoring the evolution of longer-term nominal bond yields.” Her words where enough to calm a jittery demand and turn what had been an opening loss on Wall Street into a mixed market with the Dow up in early afternoon business. Treasury yields were mostly flat on the day.

Tom Lee, managing partner and head of research at Fundstrat Global Advisors, illustrious that his “clients have already expressed some apprehension about this week. Part of this reflects the factors that bond yields have been steadily rising and equity investors are nervous that the bond customer base might reach some sort of ‘breaking point'” during Powell’s testimony.

Powell speaks Tuesday first the Senate Finance Committee when Wednesday to the House Financial Services Committee.