Global Macro: Fed Primes Yields to Correct

NEW YORK ( TheStreet) -- Federal Reserve board members have come out this week reiterating that markets have discounted an end to U.S. stimulus too soon.

The misconception had led to unjustified declines in Treasuries, causing yields to rise to multiyear highs.

Equity markets had been ready for a correction, following a run-up throughout 2013. When Fed Chairman Ben Bernanke said quantitative easing would probably be phased out completely by the middle of 2014, he triggered a massive selloff across all asset classes.

This week the Fed's tone has changed drastically from emphasizing time to moving back toward a data-dependent view. Fed officials claimed that the market selloff was because investors had lost sight of the data-dependent nature of the phasing-out process.

Bernanke's comments at the June Fed meeting were very explicit with regard to what the Fed hoped to do and the time frame it looked to do it in. This led to asset prices moving in the direction traders believed he was expressing, thus pricing in events likely to happen at least a year from now.

The first chart below is of PowerShares DB US Dollar Index Bullish ( UUP) over CurrencyShares Swiss Franc Trust ( FXF). The Swiss franc is a traditional safe-haven currency and generally experiences less volatility than other world currencies.

The dollar strengthened rapidly on the idea of a quick end to Fed easing. The dollar was driven to its upper boundaries vs. the franc, and appears to be at very overbought levels.

It remains a currency with one of the clearer outlooks relative to other global currencies, which should allow for a continued rise. Look for a moderate slowdown over the next few weeks as yields correct, but the overall trend should remain higher.

With all that the Fed officials have come out and said this week, there is now an expectation that yields will pull back in the near future. The Fed claims that markets believed that Bernanke's comments on monetary policy were hawkish, but in reality he was merely reiterating a well-known fact that when their economic targets were hit, they would reign in stimulus.

As a correction in yields takes place, look for higher-yielding debt to lead the way up.

The chart below is of SPDR Barclays High Yield Bond ( JNK) over iShares Barclays 7-10 Year Treasury Fund ( IEF). A yield correction should be bullish for fixed-income products that carry more risk factors, such as longer maturities and more credit risk.

The chart below shows that high-yielding debt is in a three-month upward channel vs. the intermediate-term treasuries. Although price action moves in and out of the two trend lines, the majority of the movement takes place within.

The fixed-income selloff did not damage this trend higher, which is bullish for riskier bond products, and is indicative of a stronger economy that these companies operate in.

The last pair is the Consumer Discretionary Select Sector SPDR ( XLY) over Guggenheim S&P 500 Equal Weight ( RSP). Consumer spending on Thursday helped prop up markets, as investors continued to believe in the U.S.'s gradual recovery.

What led to markets rallying to record highs, beginning in late 2012, was the existence of Fed support to protect the markets downside, as well as stronger economic data pushing prices higher. Market participants, pricing out quantitative easing, believed we had been left with a weak economic environment and no downward protection.

This has proved to not be the case. As stated above, the Fed has gone to great lengths to restate that it is not pulling out support until data deem it appropriate.

Similarly, stronger economic data, as seen in housing and consumer spending on Thursday, have kept investors upbeat about the U.S. economy.

As investors start believing that the Fed has not disappeared, and that the economic picture continues to improve, markets will rebound higher.

At the time of publication, Sachais had no positions in stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Andrew Sachais' focus is on analyzing markets with global macro-based strategies. Sachais is a chief investment strategist and portfolio manager at the start-up fund, Satch Kapital Investments. The fund uses ETF's traded on the U.S. stock market to gain exposure to both domestic and foreign assets. His strategy takes into consideration global equity, commodity, currency and debt markets. Sachais is a senior at Georgetown University earning a degree in Economics.

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