May the fourth be with you... Happy "Star Wars" Day. Happy Fed Day. You've made it. After this afternoon, traders, investors, economists and citizens alike will no longer have to worry about what the FOMC will do on May 4th.
For today is the day, even though the Fed has already lifted its target for the Fed Funds Rate off of the floor, that the central bank begins in earnest the great tightening cycle of 2022. To put it plainly, the Fed will be aggressive in this afternoon's official statement. Not a soul will be surprised by the announcement of an increase to that Fed Funds Rate of 50 basis points coupled with the launch of a new "quantitative tightening" program, or balance sheet run-off plan meant to drive lower the Fed's balance sheet, the monetary base, and to soak up some excess liquidity in the start of what will be the Powell Fed's greatest challenge.
That challenge being to capture consumer level inflation that has already gotten out of control. Not that all of this inflation has been the creation of the central bank, far from it. This post-crisis burst of inflation has been the child of industrial reliance upon extended supply chains as well as a distant manufacturing base, has been the child of scarcity in both energy and agricultural commodities due to the war in Europe, and has been the child of domestic fiscal irresponsibility at the legislative level where the central bank played the role of enabler.
As Tuesday night melts into Wednesday morning, it appears that the New York Rangers have lost to the Pittsburgh Penguins in triple overtime in game one of their playoff series. It also appears that futures markets trading in Chicago are now pricing in a 98% probability of that increase of 50 basis points being made to the Fed Funds Rate, and a 2% probability that the FOMC goes 75 bps. These markets are also pricing in a 92% likelihood that the FOMC tacks on 75 bps on June 15th and an 8% chance that the Fed goes a full percentage point on that date. As far as July 27th is concerned, futures are pricing in an 80% chance for a hike of 50 bps (to a target range of 2% to 2.25%) as well as an 18% chance for a 75 bps hike.
There's more. Should nothing happen to change the central bank's course, which of course is ridiculous, futures traders are betting on a 59% probability that the Fed takes the FFR up an additional 50 bps on September 21st (2.5% to 2.75%) and a 12% chance that they go 75 bps at that time. In short, these markets expect the Fed to take the FFR up 225 basis points by September and another 50 bps to make 275 in total by year's end. These markets are also pricing in a Fed Funds Rate of 3.5% to 3.75% one year from now... May 2023, up from this morning's 0.25% to 0.5%. Now, don't forget, this is outside of the "quantitative tightening" program as the size of the US economy contracted in the first quarter going into this tightening cycle. For joy, for joy.
This afternoon, the Fed will likely announce a balance sheet run-off plan that will not reinvest the proceeds from maturing Treasury and mortgage backed debt securities. There are two differences of opinion being expressed by economists going into this launch. One is in the timing of implementation. Some feel that the Fed announces today, but launches in June. I feel that the Fed implements the plan immediately, as in right now. The plan will have a monthly cap size, the Fed has already signaled $95B, as in $60B in Treasuries and $35B in MBS. There is now some professional opinion floating that while the Fed will start small and move incrementally toward that cap, that the cap will be higher than $95B.
I think the Fed may stick to $95B and if they do "go bigger" it won't be by much, maybe $100B. You all know that I think the Fed should front load the QT program in such a way that prioritizes the exit of MBS from the balance sheet. Heck I am even on board with Cleveland Fed's Loretta Mester who mentioned the possibility of selling MBS in the secondary market in order to rid the balance sheet of involvement in a market that it stayed in for way too long.
How Healthy Is the US Economy?
More difficult question to answer than it should be. We all know that the economy spent the first quarter in contraction and is now halfway to an official recession. A number of forward looking indicators are starting to roll over, but for the most part still stand in expansionary territory. We all know that while wages have fallen well behind the rate of inflation that labor markets are strong, meaning that demand for labor is strong, but not at any price.
We'll learn more about the US employment situation for April this Friday. It stands likely that the unemployment rate has dropped to 3.5%, but that wage growth has also dropped.... to 5.5% year over year, as average workweeks have expanded... to 34.7 hours. On top of this Friday's labor market survey based data, the Bureau of Labor Statistics is also responsible for tracking CPI. In March, headline CPI printed at annual growth of 8.5%. The April print is due next Wednesday.
In an IntraFi Network podcast interview that I read about at Bloomberg News on Tuesday, former Fed Vice Chair Randal Quarles sees the Fed in a tough spot, and he does throw the blame for the Fed's slow start on tackling inflation around. (Quarles served as Federal Reserve Vice Chair until December 2021.) Quarles said, "Given the intensity of inflation, the degree to which unemployment has been driven down - to bring that back into an equilibrium, it's unlikely the Fed is going to be able to manage that to a soft landing. The effect is likely to be a recession." Quarles goes on... "For an economy that has accustomed itself to interest rates as low as they have been for as long as they have been, it doesn't take a very large nominal increase in interest rates to be a very significant percentage of debt service for a number of heavily indebted actors."
Upon reading that, I paid a little visit to the website for the US debt clock. As I type out this morning's note, US GDP stands at $23.622T. US National debt stands at $30.426T. That's a debt to GDP ratio of 128.8%. This also adds up to $91K worth of debt per US citizen or $242K worth of debt per US taxpayer. Yes, that's just federal debt. Those citizens and taxpayers are in more debt than that. US Total debt (includes Federal, State, Local, Business, Financial institution, and Household debt) adds up to $90.245T or 382% of GDP. Given that all these resources contribute to GDP, does it not make sense to include all of these sources in stating a true debt to GDP ratio? There is good news. The average US family (household?) has savings of $13.6K socked away. Then again that includes the mega-wealthy. This is not the median. Uh oh.
Blame? You knew that was coming. Quarles also said... "Had clarity been provided, I think the Fed would have acted earlier." Readers will recall that President Biden did drag out the nomination of Chair Powell for a second term until November 2021. On that Quarles added, "We would have been better served to start getting on top of it in September. That was hard to do until there was clarity as to what the leadership going forward of the Fed was going to be."
The Fed claims to be data dependent. The basic problem is that what the Fed watches most closely... data-points on employment and inflation, as this is where the dual mandate lives , are composed of nothing but lagging indicators. Heck, even how the Fed will ultimately be judged... on economic growth or GDP is a seriously lagging indicator. The Fed has needed to and still needs to be anticipatory, which means reliance upon forward looking survey type indicators. They talk about inflation expectations often enough so we know it's on their radar. Use the force, Jay... use the force.
"These Aren't The Droids You're Looking For"
No, Tuesday's "up" day was not the confirmation of Monday's bullish reversal that traders and investors are looking for. While the session was positive enough in overcoming some choppy price discovery, most traders really just sat on their hands for most of the day ahead of this afternoon's FOMC policy decision.
First, the Treasury yield curve flattened on Tuesday and is still flattening ahead of that meeting... with the US Ten Year paying "just" 2.98% by day's end, 2.96% right now, and the US Two Year Note yielding 2.77% last night and 2.78% this morning.
As far as equities are concerned, small to mid-caps outperform for the session as the S&P 600 added 0.9%, the Russell 2000 tacked on 0.85%, and the S&P 400 gained 0.96%. The S&P 500 gained 0.48% on Tuesday while the Nasdaq Composite increased by just 0.22%. Nine of the 11 S&P sector-select ETFs shaded green for the session on Tuesday, led by Energy (XLE) , Four sector ETFs gained at least 1% for the session, while both Consumer Discretionaries (XLY) and Consumer Staples (XLP) closed in the red.
Winners beat losers by five to three at the NYSE and by 13 to 10 (really) at the Nasdaq. Advancing volume took 71.9% of the composite NYSE trading pie on Tuesday as well as a 62.5% share of composite Nasdaq trade. The big but, was the lack of aggregate trading volume on Tuesday. Volumes dropped from Monday's levels for NYSE and Nasdaq-listed names, as well as across both the S&P 500 and Nasdaq Composite. In short, the pros weren't playing the game on Tuesday.
Crude's a poppin' on Wednesday morning as Brussels prepares to propose a phased in banm of all Russian oil imports that would completely shut down European Union purchases of Russian crude within six months and refined Russian product by year's end. The European Commission will also propose that three large Russian banks including Sberbank be disconnected from the SWIFT international banking payment system.
Tuesday Night Party...
Advanced Micro Devices (AMD) ... beat, beat, raise, shares trading higher.
Airbnb (ABNB) ... beat, beat, positive outlook, shares trading higher.
Lyft (LYFT) ... miss, beat, projected collapse of EBITDA, shares smashed.
Skyworks Solutions (SWKS) ... in-line, beat, light guidance, shares trading lower.
Starbucks (SBUX) ... miss, in-line, suspends outlook, shares trading higher.
Livent (LTHM) ... beat, beat, raise, shares trading higher.
Western Digital (WDC) ... offered $1B to spin off the flash business, shares trading higher.
I have two favorites among the above mentioned stocks, Advanced Micro Devices, which will require a separate piece (see you in a few hours) and Livent. Livent was the first lithium stock to step to the plate this earnings season as the 'blue chip" in the space... Albemarle (ALB) reports tonight. Livent posted first quarter adjusted EPS of $0.21 (GAAP EPS: $0.28) on revenue of $143.5M. Both numbers easily beat expectations while the sales number was good for annual growth of 56.5%.
Even better, Livent increased full year revenue guidance to $755M-$835M from $540M-$600M, taking its expectations well above Wall Street's consensus view of roughly $575M. The firm also took full year EBITDA guidance up to $290M-$350M from prior guidance of $160M-$200M. Gross margin expanded to 59.9% from 13.3% for the year ago period.
The firm added that it remains on schedule to deliver all previously announced expansions including those in both Argentina and China, while adding that it is currently evaluating the building of a new facility in either North America or Europe. The balance sheet shows current assets of $364.5M, including $68.5M in net cash and $150.5M in inventories, as well as $105.5M in receivables. This measures well against current liabilities of $120.3M for a very healthy looking current ratio of 3.03. Even sans inventories, the firm's quick ratio stands at a sharp 1.78.
Total assets of $1.242.6B seriously outweigh total liabilities of $393.6M. There is no entry for "goodwill" or "other intangibles" on the balance sheet and we do appreciate that. The only thing I am not crazy about on that balance sheet is the $240.8M in long-term debt. Not that tapping debt markets is not understandable for a "newer" business, but this is a little large for the monetary environment we are going into. That said, this number is down significantly from a year ago, so it appears to me that management is on top of that.
Readers will see that these shares had recently been borderline oversold after hitting resistance at a 61.8% Fibonacci retracement of the November through March selloff. LTHM will open higher on Wednesday. The trick will be to hold the 200 day SMA at $24.59. Especially given that this is Fed Day. That's my pivot. My target price is $31.
Economics (All Times Eastern)
08:15 - ADP Employment Report (Apr): Expecting 398K, Last 455K.
08:30 - Balance of Trade (Mar): Last $-89.2B.
09:45 - Markit Services PMI (Apr-rev): Flashed 54.7.
10:00 - ISM Manufacturing Index (Apr): Expecting 58.6, Last 58.3.
10:30 - Oil Inventories (Weekly): Last +692K.
10:30 - Gasoline Stocks (Weekly): Last -1.573M.
The Fed (All Times Eastern)
14:00 - FOMC Policy Decision.
14:30 - FOMC Press Conference.