The time has come to turn the page, to put "this one" in the books. May 4th seems so long ago... March 16th even longer. They were, in market terms, a lifetime ago. Since the FOMC last met on policy, and since the committee finally got the ball rolling on raising the Fed Funds Rate. Those dates were May 4th and March 16th, respectively. The S&P 500 has given back 13.1% since May 4th and 19.5% since making a lower new high on March 29th. Not to mention that the FOMC has not put together their economic projections or their absurd "dot plot" since March 16th.
It might amuse the reader to recall that on March 16th, which is still less than three months ago, the FOMC saw as a median expectation, a Fed Funds Rate of 1.9% at year's end 2022, which was up from a 0.9% median expectation three months prior. This morning, futures markets trading in Chicago are pricing in an FFR of 3.5% to 3.75% by December 14th. Oh joy.
It was on that date the committee saw a full year GDP of 2.8% for 2022, which was down from a projection of 4.0% in December 2021. I really can not wait to see how this projection prints this afternoon after the Bureau of Economic Analysis has informed us that the US economy actually contracted (-1.5%) for the first quarter and the Atlanta Fed's GDPNow real-time model has Q2 running at +0.9%.
On that note, the Atlanta Fed will adjust that model later this morning, ahead of the FOMC's planned clambake, to account for May Retail Sales and May Import & Export prices. Atlanta will also have to revise that number in response to May Housing Starts on Thursday, so consider Atlanta's estimate to be fluid. Regardless, as the Fed decides on the trajectory of forward looking US monetary policy, tough decisions must be made.
The Choice
As Monty Hall might say, you can have what's behind door number one or door number two, but you can not have both. The grim calculus is this... choose between price stability or economic growth, which portends the likelihood of weaker labor markets. In other words, the Fed, because consumer level inflation is so hot, and so damaging, must choose to focus on one of the central bank's two mandates at the expense of the other.
As the situation now stands, those same futures markets trading in Chicago that we mentioned above, are pricing in a 96% probability of a 75 basis point rate hike this afternoon and a 4% chance for a 100 basis point (or full percentage point) hike. There is not even a market being made right now for a 50 bps increase which was the consensus view less than a week ago. Given that there is a 75 bps hike later today, markets now see hikes of at least 50 bps at the three successive policy meetings after this afternoon right through November 2nd.
Don't forget that the Federal Reserve Bank will be drawing liquidity from here on out through the maturity and non-reinvestment of the proceeds of securities now on the balance sheet. These assets have expanded the money supply and the monetary base. This is the result of the central bank having enabled behavior by the Legislative and Executive branches of government over decades that not only bordered on the irresponsible, but was quite foolhardy and for the past year and change, just ridiculous.
I don't think anyone can argue that the central bank went on supplying liquidity in the excess for far longer than it should have, in the process suppressing borrowing costs, while blurring the ability for both businesses and consumers to assess risk. I think it quite obvious that the purchase of mortgage-backed securities should have been halted as far back as January 2021, maybe even earlier as crisis conditions never even reared their ugly head in that market, even at the height of the Covid pandemic.
It would not be inappropriate in my humble opinion to consider making outright sales of these securities as a means to expedite the withdrawal of unnecessary liquidity. The process can always be halted if there is an abrupt market reaction, but as I see it, there has already been an abrupt reaction across both equity and debt markets.
First Time, Long Time
A one time a 75 basis point increase made to the target for the Fed Funds Rate would be the largest single increase made at one time since 1994, when Alan Greenspan (briefcase man) was Fed Chair. That was also the year of no World Series as the dynasty bound New York Yankees and Washington bound Montreal Expos led their respective leagues in winning percentage.
The Un-Wealth Effect
One way to slow demand is to damage individual perception of wealth. Readers may have noticed that 30 year mortgage rates soared well above 6% on Tuesday, as the yield for the US Ten Year Note scraped up against 3.5%. So long, housing market! Have you taken a look at your bond portfolio of late? If you haven't, then don't. You're poorer than you think you are.
Add that to 8.6% consumer level inflation and an S&P 500 now down 21.63% for the year, and any passive investor who does something other than what I do occupationally, has really been set up for a serious shock when they see what has happened to their retirement funds. That nest egg just is not even close to being what it was a couple of months ago.
Which brings me to one more point. I love hearing how cash is not really an option. Yes, it is. Especially in times like these. I understand that 8.6% inflation equals 8.6% erosion in purchasing power even if cash (as it must, even if backed by nothing) holds its nominal value. Would you have been better in the S&P 500? Or in Bonds? Okay, maybe in certain commodities, but even that strength has softened of late. Besides, the US dollar has been steadily gaining against its reserve currency peers this year. The US Dollar Index is up 9.26% year to date. I do not consider long cash to be a permanent or semi-permanent solution, but having a high percentage of one's portfolio in cash when said individual is nervous does seriously tamp down volatility. Do what you have to do to sleep at night. 9.26%. That's not nothing.
Emergency!
Johnny and Roy? No, Christine Lagarde and Isabel Schnabel. The European Central Bank has called for an emergency, unscheduled meeting to discuss measures to tackle spiking yields and borrowing costs in weaker (southern) eurozone economies. The meeting will start this morning in Frankfurt. It is believed that policy makers will be asked to sign off on the reinvestment of bond purchases under the already halted PEPP or Pandemic Emergency Purchase Program. Just watch Italian yields this morning for an explanation.
Where Is the Fed Put?
Not that there has to be a Fed put, especially if inflation remains at or near where it is now, but in December of 2018 the Fed allowed the S&P 500 to trade at 13.8 times forward looking earnings prior to reversing course on policy. During the pandemic panic of March 2020, the S&P 500 traded at 13.4 times forward looking earnings prior to the Fed liquifying everything.
As of Monday, according to FactSet, the S&P 500 traded at 15.8 times 12 month forward looking earnings, which is well below the five year average for the index of 18.6 times, as well as below the 10 year average of 16.9 times. The S&P 500 is trading right around its 15 year average of 15.7 times.
The implication? Though there are no guarantees in life or love, should the S&P 500 have to fall to a forward looking valuation of 13.6 times next 12 months earnings, the index would have to come in another 13.9% to alarm the Fed. Of course, by extension, this also implies that consumer level inflation has been satisfactorily tamed by then, and that earnings projections were somewhat accurate. Possibly... a double dose of unlikely events in this environment.
Good Luck, Gang
I will catch you on the flipside. To victory.
Economics (All Times Eastern)
07:00 - MBA Mortgage Applications (Weekly): Last -6.5% w/w.
08:30 - Retail Sales (May): Expecting 0.2% m/m, Last 0.9% m/m.
08:30 - Core Retail Sales (May): Expecting 0.7% m/m, Last 0.6% m/m.
08:30 - Import Prices (May): Expecting 1.1% m/m, Last 0.0% m/m.
08:30 - Export Prices (May): Expecting 1.4% m/m, Last 0.6% m/m.
08:30 - Empire State Manufacturing Index (June): Expecting 4.5, Last -11.6.
10:00 - Business Inventories (Apr): Expecting 1.2% m/m, Last 2.0% m/m.
10:00 - NAHB Housing Market Index (June): Expecting 68, Last 69.
10:30 - Oil Inventories (Weekly): Last +2.025M.
10:30 - Gasoline Stocks (Weekly): Last -812K.
16:00 - Net Long-Term TIC Flows (Apr): Last $23.1B.
The Fed (All Times Eastern)
14:00 - FOMC Policy Decision.
14:00 - FOMC Economic Projections.
14:30 - FOMC Press Conference.
Today's Earnings Highlights (Consensus EPS Expectations)
No significant quarterly earnings scheduled for release.
