The Fed isn’t worried about the rise of inflationexpectations and is not going to curb the upside in nominal risk-free rates.This is the key takeaway from Thursday speech by the head of the Fed, JeremyPowell. The main argument is that excesses in inflation pressures are temporaryand “let's focus on the labor market” (second goal under the Fed’s dual mandate).The market reaction was not long in coming: long-term Treasury bond yields soaredagain and the volatility of interest rates, according to the already worked outscenario, spread to risk assets, causing an idiosyncratic downward movement:

The move is purely triggered by the rout in bonds markets, i.e., caused by specific market phenomenon rather than general deterioration in economic expectations. Hence, the general assumption that downside in equities is a correction which should end after long-term US rates find their balance.

The Fed has made it perfectly clear that it wants more inflation before starting to change anything in the monetary policy. In this regard, there is little room for surprises at the March meeting of the Fed.

In his speech yesterday, Powell essentially admitted that the Central Bank is letting the far end of the yield curve float freely. The speech did not even contain the necessary minimum to calm the market - verbal interventions of the type, “we are closely following movements in bonds”. Nothing is holding back the flight of 10-year yields even up to 2%, given negative impact on risky assets, it is difficult to hope for a quick rebound. In the best case, we will get cautious growth attempts, but it is completely unclear what could impede further correction in bonds, i.e., clear the key hurdle for risk-on.

OPEC added fuel on the fire yesterday, deciding to prolong existing output cuts. Rising oil prices mean higher inflation expectations and this again is a blow to fixed-income assets, i.e., bonds.

Regarding today’s NFP report, the following should be kept in mind. Powell said yesterday that the labor market will take a long time to recover. To paraphrase, it will be a long time before strong NFP numbers are a hint of Fed tightening. Hence, a strong unemployment report today has the potential to exacerbate the sell-off in bonds, exposing short USD positions to additional risk.

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