May 3rd, at last.
The date has been circled on your calendar seemingly forever. Actually since March 22nd anyway, but that still seems like a long while. This afternoon, the FOMC is expected to increase the committee's target range for the Fed Funds Rate for a tenth time this tightening cycle. This will take that range up to 5% to 5.25%.
Currently, futures markets trading in Chicago, are pricing this hike in as the last of said cycle, and penciling in an 80% probability for a first rate cut on September 20th. That's one meeting earlier than when these markets had been pricing in that first rate cut earlier this week. Those futures markets have also taken the probability for an 11th rate hike on June 14th down to 0%.
What does the Fed do next? Maybe we should focus on the present and the near-term future. I am not sure that even those who comprise the rate setting committee are confident. At least not enough of them so that we might be able to set a forecast in stone. What's plain for all to see, is that the economy has slowed and continues to slow, yet still grows. What's also plain to see is that inflation has slowed, but not enough. Not even close to enough.
Those charged with the responsibility of setting monetary policy for our nation, must draw from their dual mandate for guidance. The Fed, as a group, would like to remain data-dependent in making decisions that impact the many. How to balance price stability with full employment. For the only real tools in the fight against elevated consumer level inflation are a higher interest rate regime coupled with a reduction in money supply. This creates, at least in a silo, increased US dollar valuation relative to the greenback's reserve currency peers, while damaging aggregate domestic demand at both the producer and consumer levels.
From the Fed's point of view, they probably feel that there is still some significant runway on the full employment side. This Friday, the BLS is expected to post an April unemployment rate of 3.6%, up from the 3.5% rate published for March. Historically, central bankers have considered something close to 5% as "full employment." This economy has not seen 5% unemployment since 2021.
That said, is this 3.5% unemployment rate legit? Continuing jobless claims remain above pre-pandemic levels as does labor force participation, partially in thanks to abusive fiscal policy. In March, labor force participation improved to 62.6%. Pre-pandemic, participation ran at 63.3%, and if one goes all the way back to the pre-GFC (Great Financial Crisis) era, a 66 handle was the norm.
What Am I Saying?
We are saying that the Fed is in a pickle. Obviously, a number of Fed officials who remain hawkish do not have the faith in the lag effects of already tightened monetary conditions that myself and a number of other economists do. Even if the FOMC took today off, conditions would in my opinion, continue to tighten. The fact is that the Chicago Fed's National Financial Index shows that conditions are looser now than they were in late March. That would be due to the central bank's response to the regional banking crisis, which resulted in increased liquidity. Still, this index shows overall conditions as considerably tighter than they were in February. Surviving banks will slow credit creation on their own.
I ask, in earnest... how do policy makers remain data-dependent, when in their opinion, the data calls for continued confrontation versus inflation, when we know that the labor market has only just started to show the weakness that it is capable of, as the lag effect of past policy decisions is probably something like six to nine months behind, and as we know that increasing short-term rates only exacerbates the problem in creating net interest margin across the regional banking space? These banks are forced to reduce their own potential for success in order to attempt to compete for cash deposits... just to remain viable.
I think readers already know that if asked for guidance (which has not happened), I would have already recommended a pause in using short-term rates in the fight against inflation, while permitting past rate hikes and the Fed's quantitative tightening program to work their magic, thus showing caution in exacerbating already damaged banking conditions and preserving current employment conditions as close to where they are now as possible.
Wage growth has already fallen off of a cliff. That might be all the damage the public can handle right now. Putting individuals out of work will not only slow economic activity, which is what the Fed wants, but will also place an increased burden upon the state. If one hasn't noticed, the "state" is already well beyond their depth.
It has often been said that Tuesday's child is full of grace. In this case, maybe "they" were talking about Tuesday afternoon as equity markets bottomed about a half hour before noon on the east coast. Was it fear of higher interest rates? Fear of more trouble across the regional banking space? Perhaps it was just a plain old fear of recession. Regardless of reason, 10 of the 11 S&P sector-select SPDR ETFs closed lower on Tuesday led in that direction by Energy (XLE) and the Financials (XLF) .
The Energy SPDR gave up 4.35% as WTI Crude itself gave up 5%. Just an FYI... crude continues to sell off overnight. The Financials SPDR surrendered 2.27% on Tuesday, as the KBW Bank Index took a beating of 4.31% and the KBW Regional Banking Index lost 4.81%.
The KBW Regional Banking Index has now given up 33% since early February and 28% since cracking during the second week of March. The broader indexes were not hit quite as hard as were these two sectors. This was the case, at least after a mild afternoon rally that allowed the S&P 500 to close down 1.16% and the Nasdaq Composite to close 1.08% lower.
Losers beat winners at the NYSE on Tuesday by a rough 4 to 1 margin. This is where it gets scary. Advancing volume took just a 16.5% share of composite NYSE-listed trade as total NYSE-listed trade increased 35.1% day over day. What does that mean? It simply means that the pros ran for the hills one day ahead of the Fed and for the most part took profits and losses just to reduce exposure.
The selling was less reckless at the Nasdaq. Losers beat winners by about 5 to 2. Advancing volume took a 34.4% share of composite Nasdaq-listed trade as total Nasdaq-listed trading volume increased 6.4% day over day. What that means is that traders were less eager to abandon some of the tech names that either have just reported or are about to.
On that note, Sarge name Advanced Micro Devices (AMD) posted solid earnings on Tuesday afternoon, but on mixed to soft guidance. The name has been trading about 6% lower overnight. Readers do know that I did cut this position ahead of earnings season. I have not further reduced my long position overnight. I have not yet decided where to add what was sold back on to my core position.
The real action, as if the action across the equity and energy spaces were not enough, was in Treasury markets. On Tuesday, traders aggressively bought US sovereign debt. The US Ten Year Note saw its yield drop 15 basis points to 3.43% as the yield for US Two Year Note decreased by 16 bps to 3.98%. I see these two yields at 3.40% and 3.94% this morning respectively, suggesting that the demand for these products may still have room to run.
The spread between the US Three Month T-Bill and the US Two-Year Note, which is historically the most accurate predictor of economic contraction at our disposal, made yet another multi-decade low on Tuesday, going out at -180 bps. Oh joy.
Economics (All Times Eastern)
07:00 - MBA 30 Year Mortgage Rate (Weekly): Last 6.55%.
07:00 - MBA Mortgage Applications (Weekly): Last 3.7% w/w.
08:15 - ADP Employment Report (Apr): Expecting 146K, Last 145K.
09:45 - S&P Global US Services PMI (Apr-rev): Flashed 53.7.
10:00 - ISM Non-Manufacturing Index (Apr): Expecting 51.8, Last 51.2.
10:30 - Oil Inventories (Weekly): Last -5.054M.
10:30 - Gasoline Stocks (Weekly): Last -2.408M.
The Fed (All Times Eastern)
14:00 - FOMC Policy Decision.
14:30 - FOMC Press Conference.