"Real knowledge is to know the extent of one's ignorance."
-Confucius
Again, I Ask...
Just what provoked the Indirects to be so aggressive at Wednesday afternoon's 10-Year Note auction, falling all over themselves in a rush to pay above-market prices? Just what provoked portfolio managers up and down Wall Street to race each other, adding equity risk that same day? As I have mentioned, it sure felt like somebody knew something. Apparently, few knew anything at all. A stampede based on a hunch. Just awesome.
Cages Rattled
The Bureau of Labor Statistics rattled enough cages on Thursday morning with the release of January data for consumer prices. By now, you all know that at the headline and at the core, 7.5% and 6% year-over-year inflation was a bit hotter than consensus, and a lot hotter than the whispers that were apparently based on hope. Atlanta Fed President Rapahel Bostic correctly told us to prioritize watching the month-over-month data as the year-over-year numbers are not just hot, but wonky and about to get wonkier as we close in on lapping the initial spike into this new inflationary era last March.
So, we look at the monthly data. For January, the 0.6% increase over December at both the headline and the core is hotter than projections, but at least at the core, not an acceleration of pace. For the month, gasoline prices actually fell 0.6%, dragging on inflation. Both apparel and transportation services experienced above-trend price increases for the month, but below-headline inflation on an annual basis. New vehicles saw no increase at all in January, while used vehicles refused to cool.
In other words, this era of inflation is broadening beyond an initially narrow set of goods. Does that happen as inflation soars to nearly out-of-control levels? It seems that some, including St. Louis Fed President James Bullard, certainly fear this. Fear is healthy. Panic is not. Does this broadening occur just before the beast tempers its anger? That may also be true.
Let's Discuss
We know that supply has been constrained. This is a condition of the pandemic-era economy. Should a new, more virulent variant of the SARS-CoV-2 coronavirus arise from let's say the Alpha/Delta line of descendancy, then yes, the bonfire will persist. Should the next variant of note descend from Omicron, then we, as people, could be closer to resuming if not our old lives, at least one more comfortable than we have become accustomed to.
Can the Fed or any central bank correct for logistical deficiencies based on regional lockdowns? Of course not. Supply chain issues are fixable, though not through policy. Corporations that have been slow to shorten supply lines will continue to suffer for it. Those that understood what they were up against will benefit. One thing that central banks can do to slow inflation would be to slow demand. This, the Federal Open Market Committee (FOMC) is certainly capable of, through tightening monetary conditions. Through increasing short-term rates and draining overall liquidity, the Fed intentionally will punch the economy in the nose.
Is purposefully slowing economic activity in order to arrest inflation worthy of the price paid? At these levels, the crowd screams "Certainly." As I have mentioned often, while I agree that a 2% 10-Year is terribly out of tune with 7.5% inflation, aggressively raising the target for the fed funds rate may be the wrong approach. Monetary policy jumped the shark a long time before Jerome Powell or even Janet Yellen led the Fed. We can't correct for how disgracefully far earlier Feds and their correlative legislatures took the fiat currency based, deficit spending supercycle, robbing ever further tomorrows to feed the present. Those sins against the masses have been committed, unfortunately, with the robust approval of said masses.
Normalizing policy will have different meanings to different folks. For some, it would simply mean slowing consumer inflation to something less painful than this. For others, it would mean significantly reducing future risk, in other words, removing the overbearing presence of artificial participation in pricing credit over time while reducing a significant enough percentage of the monetary base.
Simply put, I think investors, traders and, most importantly, citizens must understand that we have spent the better part of our careers at the banquet. For the most part, this feast has been methodical with occasionally urgent surges in energy based upon the crisis of the decade. Removal will need to be methodical. My suggestion to the Federal Reserve Board of Governors would be to take baby steps on rates while getting to work on the balance sheet sooner rather than later. (For crying out loud, right this second, the FOMC is still buying assets.)
What happens if liquidity is drained from this economy more aggressively than raising rates in chunks? I'm smart enough to know that I don't know. However, I do know that if overnight rates are increased dramatically over a short period of time, that Main Street will feel it as hard as Wall Street. Going my way may place a higher burden on risk asset markets but hit the average household less severely. At least think about it. We who draw our living from varied marketplaces will evolve. We always do. Main Street is not like that. They will lose jobs. They see less hours worked. They will not adapt as well. All as consumer prices remain more a result of scarcity and probably less susceptible to front end policy than you think.
Additionally, more affordable real estate pricing could benefit household formation across younger and less wealthy swaths of the economy. But not if access to affordable credit rapidly replaces nominal cost as the primary barrier to entry.
That Said....
Markets took Thursday's Consumer Price Index (CPI) print badly. They took James Bullard's comments made on Bloomberg TV even worse.
Bullard said...
"I'd like to see 100 basis points in the bag by July 1. I was already more hawkish, but I have pulled up dramatically what I think the committee should do...
"There was a time when the committee would have reacted to something like this to having a meeting right now and doing 25 basis points right now. I think we should be more nimble and considering that kind of thing.
"As a general principle, I see no reason why you can't remove accommodation just as fast as you added accommodation, especially in an environment where you have the highest inflation in 40 years."
On that last note, I agree as far as balance sheet management is concerned. Indeed, Cleveland Fed President Loretta Mester is on the right track when she considers the outright selling of mortgage-backed securities. The FOMC never belonged in those markets in the first place. Of course, the finesse of a surgeon would be needed, and not the brawn of a lumberjack. The Fed would need to hire professional traders. James Bullard was honest. He always is. For that, we love him. He did single-handedly panic financial markets today more than the raw data did on its own. For, if that was "fair warning," we thank him. If not, then "what gives, dude?"
The Ugly Stick
The Nasdaq 100 gave up 2.33% on Thursday, surrendering its 21-day exponential moving average (EMA) and 200-day simple moving average (SMA). The Nasdaq Composite retreated 2.1% and gave up its 21-day EMA. The S&P 500 lost 1.81%, lost its 21-day EMA and now once again will test support at its 200-day SMA (really crucial). Small- to mid-cap indexes all gave up between 1.39% and 1.55%.
The beating was broad. All 11 S&P sector-select SPDR ETFs closed in the red, three of them down more than 2%, another five down between 1% and 2%. Materials XLB were your out-performer, down "just" 0.58%. Cyclicals out-performed defensive sectors as defensives tend to be more sensitive to rising yields.
Losers beat winners by a rough 3 to 1 at the New York Stock Exchange and by about 5 to 2 at the Nasdaq. Advancing volume comprised 30.2% of the composite for names domiciled at 11 Wall Street and 25.4% of the composite for stocks with a home address up at Times Square. Aggregate trading volume was very heavy, dramatically heavier than it had been for a couple weeks. To say that there was professional distribution on Thursday would be to understate what transpired.
Debt markets were paid a visit by the ugly stick as well, even more so. The yield for the US 10-Year Note spiked above 2.05% on Thursday, up 12 basis points, while the yield for the US Two-Year Note tapped 1.62%, up 25 basis points. The flattening of the curve was at least as startling as the precipitous fall in value for these securities. The US Three-Month T-Bill paid as much as 40 basis points on Thursday (still does), up from just 27 basis points prior to the CPI print.
Oh yeah... the 10-Year /Two-Year yield spread looks real healthy.
You May Want to Sit Down
Futures trading in Chicago is now pricing in the near certainty of 50-basis-point liftoff for the fed funds rate on March 16. These markets are also pricing in a 25-basis-point hike on May 4 and another 50-basis-point hike on June 15. So, futures are now pricing in 125 basis points of increases (Bullard only asked for 100) by July 1 (three meetings). By the way, that's when the new Boston Fed President Collins will enter the fray.
Futures then price in a pause in July, and subsequent 25-basis-point increases in both September and November. Right now, that's it for the year, so 175 basis points for 2022. Of course, the Atlanta Fed GDPNow model currently has the first quarter running at growth (quarter over quarter, seasonally adjusted annual rate) of 0.7%. What could possibly go wrong?
One More Thing...
Remember how we kept harping about how OPEC+ was having capacity issues more than holding back on production? Yeah, sit back down. OPEC+ has boosted production quotas by 400,000 barrels per day a month since mid-2021. Core OPEC nations were allotted 254,000 out of the 400,000, while the "plus" nations led by Russia had been allotted the balance up to 400,000. Just an FYI, for obvious reasons, Libya, Venezuela and Iran are not considered core.
Official results for January are in this (Friday) morning. It appears that the core 10 nations of the cartel were only able to increase production by 135,000 barrels per day versus their 254,000 target/quota. The core is now 784,000 barrels per day below these self-imposed quotes since implementation. The three nations outside of the core combined for a net reduction in production of 33,000 barrels per day. Russia, for that matter, only managed an increase of 85,000 barrels per day for January despite being allotted 100K,000 (out of the 146,000 allotment for the "plus" group).
Who Would Have Thought?
Who would have thought 24 hours ago that Uber Technologies (UBER) would have sold off on its Investor Day? Who would have thought 24 hours ago that I might not be called away on my Disney (DIS) long, or that it might be worth being called away when accounting for premiums realized? Kooky. Anyway, I would like to thank the wonderful world of Disney for doing its part to help support my P/L on Thursday. Now, can you please bring back Mr. Toad's Wild Ride?
Economics (All Times Eastern)
10:00 - U of M Consumer Sentiment (March-adv): Expecting 67.5, Last 67.2.
13:00 - Baker Hughes Oil Rig Count (Weekly): Last 497.
The Fed (All Times Eastern)
No public appearances scheduled.
Today's Earnings Highlights (Consensus EPS Expectations)
