The wait is over. Or at least this particular wait is over. The Federal Reserve's FOMC (Federal Open Market Committee) will release their latest monetary policy decision this afternoon at 14:00 ET, along with the group's forward looking economic projection.
A half hour later, what will likely be the real show, or what will be the driver for financial markets for the rest of the week and beyond will commence as Fed Chair Jerome Powell will run what may be the wildest and most important press conference he has had to deliver and endure in at least a couple of years.
Powell will be barraged with questions regarding the health of the US banking system and what exactly went wrong at several specific banks by what will be a rabid financial media corps who all want to know the same things.
The FOMC, as well as Jerome Powell, have signaled ahead of this meeting, really just two weeks ago, that higher interest rates were needed in order to keep fighting consumer level inflation, especially in places where this inflation has been and is expected to remain sticky. The debate at that time was between increasing the target range for the Fed Funds Rate either another 25 basis points today or perhaps moving back to larger (50 bps) increases with an intent to keep rates "higher for longer."
Shortly after Powell testified before the appropriate Senate and House committees, the entire world changed dramatically. For those who wondered how close the Fed was to actually breaking something by keeping short-term rates artificially low for too long and then trying to make up for that lag with speed and aggression in tightening monetary policy over a year's time, their question was answered.
The Fed had forced depositors to move savings from banks where they were paid next to nothing (because banks have to try to create margin) to T-Bills or Money Market mutual funds where these savings could earn a few percentage points. This put some of the regional banks in a bad place, and accelerated the withdrawal process as runs forced regulators to shutter more than one bank and the larger industry players to try to rescue another.
Tick, Tick, Tick...
The members of the committee are in between the proverbial "rock and a hard place." There is pressure to keep increasing short-term rates in order to maintain some semblance of credibility as this increase has been signaled. For the month of February, consumer prices cooled somewhat, but not as quickly as hoped for, but producer prices did show some deflation, not simply disinflation. That's a positive. This "credibility" thing is the argument for an increase of 25 basis points. 50 basis points is no longer considered realistic.
There is also great pressure upon the Fed to acknowledge that there has been a great shock to the banking system both domestically and abroad within the past two weeks and enter into a policy pause. The Fed will have to explain providing liquidity to banks in size that retraced nearly half of all of the progress made in shrinking its balance sheet through quantitative tightening in just one week.
The Fed will have to explain the failures of Silicon Valley Bank (SIVB) , Signature Bank (SBNY) , the strenuous measures being made by the banking community to preserve the viability of First Republic Bank (FRC) , as well as perceived weakness across the entire industry to include that spectacular bail out in Europe of the globally significant Credit Suisse (CS) .
Those hoping to see a pause in the trajectory of policy this afternoon do have some logic on their side. While not quite out of the woods as far as the potential for further contagion is concerned, it would not be difficult to imagine a short to medium-term future where far more caution is shown in the extension of credit to businesses and households. Regional banks are where local businesses find funding for whatever it is that they do. This will almost certainly slow economic activity and pressure commercial real estate, not to mention employment.
Wild swings in pricing for Treasury market securities have put an obvious level of uncertainty on display going into this policy meeting. Over the past three weeks, the US Ten Year Note has paid as much as 4.06% and as little as 3.43%, while the US Two Year Note has paid as much as 5.07% and as little as 3.82%. The yield for that Two Year Note is regarded by traders as something of a guideline for the FOMC.
These are the yields for the US Ten (green) and Two (red) Year Notes over the past three months. Readers will note that the red line, which is the important one here, has turned sharply higher this week, but remains far lower than it had been in early March. Perhaps most importantly, this line went out on Tuesday, believe it or not, slightly above where it was the last time the FOMC issued a policy decision on February 1st.
What Does That Mean?
The implication would be for a small rate hike, which I think is already priced in across most financial instruments at this point. As we move through the zero-dark hours on Wednesday morning, Fed Funds Futures are pricing in an 88% likelihood for a 25 basis point increase to be made to the target range for the Fed Funds Rate this afternoon. That will get this range up to 4.75% to 5%. Markets are also pricing in a 61% probability for another 25 bps rate hike on May 3rd, which would put what would be the terminal rate at 5% to 5.25%. The first rate cut is currently priced in for July, with the Fed Funds Rate seen at 4.25% to 4.5% by year's end and a rate of 3.5% to 3.75% seen by June 2024.
For this afternoon, I do think that the Fed goes ahead with a 25 bps hike. I don't think that this is very wise right now, as caution is what's called for in this environment. That said, I do not think that the small face-saving hike amounts to overt policy error as long as the messaging around the hike sounds dovish. The Fed, either through the statement or in the projections or in the press conference is going to have to show a sensitivity to the current fragility across the banking system as well as the greatly increased likelihood for a slowdown in economic activity that will now be more severe than anticipated.
An announced pause would be my preference. I do not think it likely, but that is the route that I would go. Basically, investors should be mentally prepared to deal with either a dovish sounding rate hike or a hawkish sounding pause. Either way, Powell is going to have to get through that press conference, which will be a real gauntlet this afternoon.
For those that were with me on the First Republic and KeyCorp (KEY) trades laid out at Real Money ahead of Treasury Secretary Yellen's speech, I am now flat those two names. I would not come into Fed Day wearing either position. Too much risk. The FRC trade outperformed my 20% target (+28%), while the KEY trade underperformed my 10% target, but still managed to show green for the session (+5%).
I am coming into Wednesday, skinny as I would not be surprised to see some giveback later. Not that I have the audacity to expect anything these days. We've just had a couple of nice days, nicer than expected, and I thought it wise to take (trading, not core) profits ahead of this afternoon.
Equity markets were strong again on Tuesday, and breadth improved from that less than impressive rally on Monday. That said, trading volume was once again rather light and will likely remain so until this afternoon. The headline indexes showed strength, with the S&P 500 up 1.5% and the Nasdaq Composite up 1.55%.
Readers should note that the S&P 500 hit resistance at its 50 day SMA (simple moving average) on Tuesday, and despite having retaken the 4,000 level, has still not retaken the 50 day line which is far more important. For a change, the Dow Transports (+1.67%) did help push the S&P 500 higher, while the Philadelphia Semiconductor Index (+.07%) was a drag on the Nasdaq Composite. The KBW Bank Index rallied hard (+4.96%) during the session, thanks to Secretary Yellen.
Cyclical sectors managed to outperform more Defensive sectors on the session as Energy (XLE) , Discretionaries (XLY) and Financials (XLF) led the way and Utilities (XLU) gave up more than 2%. Winners beat losers by a rough 7 to 2 at the NYSE and by about 8 to 3 at the Nasdaq Market Site. Advancing volume took an 82.8% share of composite trade for NYSE-listed names and a 78.8% share of that metric for Nasdaq-listings.
However, aggregate trading volume decreased on a day over day basis as well as a week over week basis for names listed at both exchanges for a second straight day. Trading volume across the constituent membership of the Nasdaq Composite has now failed to reach its own 50 day trading volume SMA for each of the past two days.
Good luck today, my loyal band of readers.
Economics (All Times Eastern)
07:00 - MBA 30 Year Mortgage Rate (Weekly): Last 6.71%.
07:00 - MBA Mortgage Applications (Weekly): Last 6.5% w/w.
10:30 - Oil Inventories (Weekly): Last +1.55M.
10:30 - Gasoline Stocks (Weekly): Last -2.061M.
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)
Before the Open: (OLLI) (.79)
After the Close: (CHWY) (-.10), (WOR) (.73)
(Energy Select Sector SPDR Fund is a holding in the Action Alerts PLUS member club. Want to be alerted before AAP buys or sells XLE? Learn more now.)