"The clouds methought would open and show riches
Ready to drop upon me, that when I waked,
I cried to dream again."
- Caliban (Act 3, Scene 2), "The Tempest" by William Shakespeare
Thunder
The sound was unmistakable. A low roar at first, then built into a prolonged, deafening blur.
What? I can't hear you. Find shelter. We can't. Caught out in the open. Hang on! Hang on to what? Oh no!
The early morning had been bright and sunny, a broad sense of optimism had filled the children with delight. It was going to be OK. I think. Heck, what do I know? Those clouds sure look different.
Hurricane Jerome. The Nasdaq Composite had been up almost 2% on Thursday morning. Birds were singing. We heard two young people giggling over there. Not a care between them. Ring the bell, ring the darned bell! Aye, by the time that mighty bell tolled, the damage had been done. The yield curve had been pushed out. The Nasdaq Composite closed down 2.07% after finally making contact with that coveted 50-day simple moving average (SMA), a line that was indeed crossed over, or should I say under by its own 21-day exponential moving average (EMA)...
Of course, the midday carnage (reversal) was not confined to the Nasdaq. The S&P 500 closed down 1.48%. Our broadest large-cap equity index had actually pierced its 200-day SMA shortly after the opening in New York. If that line could have been held, at least in theory, a certain percentage of portfolio managers would likely feel compelled to add risk exposure to their portfolios. Alas, there was only failure at this level...
Not only would the S&P fail at the 200-day line, the index would by day's end surrender both its 21-day EMA and even its 50-day SMA. Thus, some of those very same managers who had nearly been compelled to add risk as the sun shone down upon them felt inclined to shed risk instead as the cold April rain pelted their unshielded faces with misery. The small-caps were hit hardest of all as the Russell 2000 took a 2.29% beatdown. Nearly all US equity indices ended Thursday with April lows staring at them from not very far below. What on earth was that?
The Fed Chair
The Federal Open Market Committee (FOMC) will now go into the "blackout period" ahead of its May 4 policy decision. With Fed Chair Jerome Powell appearing publicly ahead of that blackout period, he made sure that markets had no choice but to better understand how committed the committee is to tackling inflation, even to the point of damaging labor markets. Powell's words set off a keyword-reading algorithmic feeding frenzy that was felt across both debt and equity securities markets, but that was not whom he was addressing. He was addressing you and I, Bucko. While I may not enjoy what Powell said, he was, if anything, transparent. He knows what he thinks the FOMC must do, and he very simply hit us over the head with it. Bonk.
On the trajectory of raising the target for the fed funds rate, Powell said, "It is appropriate in my view to be moving a little more quickly. We make these decisions at the meeting and we'll make them meeting by meeting, but I would say that 50 basis points will be on the table for... May." Then Powell really dropped the bomb on markets: "We really are committed to using our tools to get 2% inflation back."
I want you to stop right here and just think about how much demand destruction there has to be, assuming that the war in eastern Europe drags on and that the pandemic continues to hamper supply lines, for inflation to return to 2%. Even in my earliest models, pre-war and pre-Omicron sub-variants, although I saw inflation as transitory (and peaking with a 6 handle), I never saw consumer-level inflation realistically dropping below 3% to 3.5% prior to the FOMC being forced by one reason or another to slow down on quantitative tightening. This is now from a much higher perch, with a much lower target.
There were other Powell tidbits that caught market attention on Thursday. The Fed chair also said, "We're really going to be raising rates and getting expeditiously to levels that are more neutral and then that are actually tightening policy if it turns out to be appropriate once we get there." Hmm, that doesn't sound very cautious. Powell adds, "It's absolutely essential to restore price stability. Economies don't work without price stability." There, I think we can all agree. The point, though, is that Powell is driving home exactly where his focus is and what his priorities are.
Policy
As you and I work our way through the wee hours on Friday morning, April 22, 2022, the Fed's target for the fed funds rate stands at 0.25% to 0.5%. This is where it has been since the March meeting. The Fed's balance sheet, as of last night, stands at $8.956 trillion, which was down small (-$9.6 billion) from the week prior, which I believe to have been the high water mark.
Futures market trading in Chicago is currently pricing in a 98% probability of a 50-basis- point rate hike on May 4 and a 2% chance for more than a 50-basis-point increase. The June 15 meeting gets interesting. These same futures markets are pricing in a 92% probability of a 75-basis-point (or more) hike in June on top of May's 50-basis-point hike, taking the fed funds rate up to 1.5% to 1.75%. Picture that. Less than two months from today, the market expects the FFR to have jumped from today's 0.25%-0.5% up to 1.5%-1.75%. I am not done.
We turn the page to July 27. Futures markets are pricing in an 86% probability that the FOMC tacks on another 50-basis-points (or more) at that meeting on top of the 125 basis points already added in May and June. These markets see the fed funds rate at 2% to 2.25%, an incredible 175 basis points higher than they are now in little over three months' time. Front loaded? You can say that again.
At the same time, as this really all-out attempt to slow economic activity is made on Main Street's front door, we know that the Fed is very likely to announce and perhaps launch its program to reduce its balance sheet in May. What is expected is a roll-off of maturing securities that will be incrementally built up to $95 billion a month ($1.14 trillion annualized), comprising $60 billion in Treasury securities and $35 billion in mortgage-backed securities.
While increasing short-term rates will undoubtedly slow activity and almost certainly labor markets with it, reducing the slosh is really good housekeeping at this point. We can't blame the Fed or the US government for whatever percentage of consumer-level inflation has been caused by Russia's war on Ukraine or by Beijing's strict anti-pandemic policies. That said, the slosh (the size of the monetary base) is certainly Washington's doing.
There is no doubt that quantitative easing lasted far longer than the pandemic's impact on the US economy and that there was almost never a need for the purchase of mortgage-backed securities to last much beyond January 2021. This was a foolish expansion of money supply just to keep short-term rates artificially low for longer than any crisis demanded, and is at least a full partner with the war and the supply chain in why inflationary pressures lasted longer and went higher than they should have.
What the Fed Probably Should Do
My opinion, as an economist, probably comes from a different place than does most policy focused opinion. I come from the people, not the castle. The Fed has to act aggressively. We know this. I'm pretty sure that Main Street is going to feel whatever the Fed does. However, I think the front-loaded aggressiveness is probably better served in removing the slosh of the balance sheet with a bit more fervor than attacking the short end of the Treasury curve.
Rates are too low and have been too low forever. That's not new. The size of the balance sheet? That's new. Almost double the 2017 peak. Removing this "back door" accommodation would certainly impact asset prices, and perhaps is the price we must pay as we have never really paid earnestly for the market's pandemic run. Going hard on rates early will shock Main Street. These folks will not know what hit them. Perhaps that's the intent -- to simply crush broad, discretionary consumer demand. Does that restore the flow of oil and natural gas from Eastern Europe? Does that get factory and seaport workers in China back to work? I bet it doesn't.
The good folks of Gotham and elsewhere will spend what they have to in order to procure the staples of life for their households. They will borrow more than they want to, at higher rates than they are comfortable with. The academics will point to how resilient the incredible US consumer is. Then it happens. A trickle at first. Then a stream turns into a flood as the layoffs begin.
Or... you can do it my way. Twenty-five basis points at a time on the front end, while aggressively removing the slosh of the balance sheet, with a heavy focus on removing mortgage-backed securities until they are off sheet completely, even reversing the 60/35 breakdown. I don't think this is difficult material.
The members of the FOMC should be able to understand my words. More expensive mortgage rates? How about more affordable household formation? Get younger families in the game. I would, and I think it's imperative to protect Main Street for longer. Unfortunately, it seems to me that I stand alone.
Thunderstruck
"I was caught
In the middle of a railroad track (THUNDER)
I looked 'round
And I knew there was no turning back (THUNDER)
My mind raced
And I thought, what could I do? (THUNDER)
And I knew
There was no help, no help from you (THUNDER)"
- Angus and Malcom Young (AC/DC), 1990
Economics (All Times Eastern)
08:30 - Markit Manufacturing PMI (Apr-Flash): Expecting 58.1, Last 58.8.
08:30 - Markit Services PMI (Apr-Flash): Expecting 58, Last 58.
13:00 - Baker Hughes Total Rig Count (Weekly): Last 693.
13:00 - Baker Hughes Oil Rig Count (Weekly): Last 548.
The Fed (All Times Eastern)
No public appearances scheduled.
Today's Earnings Highlights (Consensus EPS Expectations)
Before the Open: (AXP) (2.46), (CLF) (1.47), (HCA) (4.27), (SLB) (.33), (VZ) (1.35)
