"Nothing about the data suggests to me that we've tightened too much."
- Federal Reserve Bank Chair Jerome Powell, Tuesday, March 7, 2023
Reset Accomplished
If Fed Chair Jerome Powell had set out on Tuesday morning with an idea to reset forward looking market expectations in regard to the trajectory of monetary policy, then "Mission Accomplished." It had become common knowledge that US bond and equity markets had diverged on what exactly had become "priced in." Powell in no uncertain terms, let the public know that while neither may have been exactly correct on the central bank's current thinking on the matter, that the bond market had been closer. Perhaps much closer to where the Fed is now headed. At least that is since the bulk of the macroeconomic data for the month of January started hitting the tape about a month ago.
On those numbers, Powell commented... "The data from January on employment, consumer spending, manufacturing production, and inflation have partly reversed the softening trends that we had seen in the data just a month ago. Some of this reversal likely reflects the unseasonably warm weather in January in much of the country. Still, the breadth of the reversal along with revisions to the previous quarter suggests that inflationary pressures are running higher than we expected at the time of our previous Federal Open Market Committee meeting."
Taking that thought a step further, Powell got into the nitty gritty and stepped into the next fat pitch down the middle that he saw... "The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated. If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes."
Got It?
The event wore on through the morning hours and went in a number of different directions, as surely will Powell's appearance before the House Financial Services Committee will this morning. If Powell thought that maybe he came on too strong, he had ample opportunity to walk back or moderate his thoughts. Instead, when the opportunity arose, Powell dug in... "We're looking at a reversal, really, of what we thought we were seeing to some extent."
On the short-term future, Powell said... "We will continue to make our decisions meeting by meeting, taking into account the totality of incoming data and their implications for their outlook for economic activity and inflation."
Finally, Powell launched an uppercut to the markets after having stunned the algorithms that control price discovery with a right cross to the jaw... "As I mentioned the latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated."
Reaction
Yes, equity markets took on some damage on Tuesday. That was as much in response to a dramatically stronger US Dollar Index and a rapidly changing Treasury yield curve as anything else as bond traders pounded the US Two Year Note into submission.
Readers will see that the US Dollar Index, also known as "the Dixie" or DXY made new highs for 2023 and reached for levels not seen since the Fed started to talk about slowing down the pace of increases for the benchmark Fed Funds Rate last November.
Readers will also see the yield for the US Two Year Note pull noticeably away from the yield for the US Ten Year Note...
Perhaps this divergence is best illustrated by the sudden increase in the size of the negative inversion of the spread between the two, as the Ten Year/Two Year yield spread hit levels not seen since September 1981...
The other spread that we watch very closely, that being the spread between the yields of the US Ten Year Note and US Three-month T-Bill, also remains badly inverted but has not yet made new lows for 2023...
I would think that one would have to admit that after Tuesday, the probability that the Fed feels forced to push the US into a period of contracting economic activity in order to seriously slow inflation has greatly increased.
At the moment, futures trading in Chicago are now pricing in a 74% likelihood for a 50-basis point increase to be made to the target for the Fed Funds Rate on March 22nd, with a 26% probability for a 25-basis point increase. These numbers have more or less reversed since the start of the week. These markets are also now pricing in a terminal rate of 5.5% to 5.75% (up 25 bps from Monday) that is reached by the June 14th FOMC policy meeting and held into the January 2024 meeting when the first rate cut of this cycle now has a 54% chance.
Equities
Not a single equity market index or equity related index that I follow ended the day in the green on Tuesday, unless one counts the VIX, which is really equity-adjacent more than it is equity-related. The S&P 500 gave up 1.53% on Tuesday as the Nasdaq Composite surrendered 1.25%. Looking into other areas of focus, the Dow Transports lost 1.25%, the Philadelphia Semiconductor Index lost 1.07%, the Russell 2000 lost 1.11%, which is all fairly uniform until one gets to the financials. The KBW Bank Index was taken out back and beaten to the tune of 3.87% for the session.
Why would the banks take the brunt of Tuesday's selloff you ask? Aren't higher interest rates good for net interest margin? Well, they are when shorter-term rates are not higher than longer-term rates. The banks also don't do so well during periods of economic recession as demand for credit dries up as business and households cut back on spending plans and the mortgage business ebbs as there will not only be little upward movement or even refinancing plans taken on by households paying mortgage rates far below current levels.
I did not exit my bank stocks on Tuesday, but I did reduce my exposure to the space by close to 50%, as the basis for that investment was hinged upon what I had once thought appeared to be an improved environment for traditional bankers. I am still up between 7% and 8% for both Bank of America (BAC) and Well Fargo (WFC) , so the paring down was done while the trades were still profitable and at least now the positions are right-sized relative to the economic uncertainty faced by the industry.
All 11 S&P sector-select SPDR ETFs closed deep into the red on Tuesday. Consumer Staples (XLP) were the top performing sector at -0.99%, while the REITs (XLRE) and Financials (XLF) both surrendered more than 2.5%. Losers beat winners by about 4 to 1 at the NYSE and by almost 5 to 2 at the Nasdaq. Advancing volume took a 15.6% share of composite NYSE-listed trade and a 26.3% share of that metric for Nasdaq-listings.
Interestingly, aggregate trading volume increased significantly on a day over day basis across the entirety of Nasdaq-listed securities as well as across the constituency of the Nasdaq Composite. However, aggregate trading volume edged lower on a day over day basis for NYSE-listed names as well as across the constituency of the S&P 500.
The implication? That profit taking was heavy, but that there is still no rout in place. The S&P 500 is still in contact with its 50-day SMA and still closed well above its 200-day SMA, while the Nasdaq Composite still stands well above both. This market does not break unless those 200 day lines come under fire as they did last week and fail to show the strength shown at that time. On that note Powell round two kicks off in a few hours, Friday brings with it the BLS February jobs data and next Tuesday is CPI Day. Plenty of ammo for those looking to act.
Oh, the Fed also publishes the Beige Book this afternoon while Treasury brings $32B worth of ten-year paper to auction.
Powell on Cryptocurrencies...
"We don't want regulation to stifle innovation in a way that just favors incumbents and that kind of thing. But, like everyone else, we're watching what's been happening in the crypto space and what we see is quite a lot of turmoil, we see fraud, we see a lack of transparency, we see run risk."
Powell on a Potential US Debt Default...
"Congress really needs to raise the debt ceiling - that's the only way out. If we fail to do so, I think that the consequences are hard to estimate, but they could be extraordinarily adverse and could do long-standing harm."
Economics (All Times Eastern)
07:00 - MBA 30 Year Mortgage Rate (Weekly): Last 6.71%.
07:00 - MBA Mortgage Applications (Weekly): Last -5.7% y/y.
08:15 - ADP Employment Report (Dec): Expecting 188K, Last 106K.
08:30 - Balance of Trade (Jan): Last $-67.4B.
10:00 - JOLTs Job Openings (Jan): Last 11.012M.
10:00 - JOLTs Job Quits (Jan): Last 4.087M.
10:30 - Oil Inventories (Weekly): Last +1.166M.
10:30 - Gasoline Stocks (Weekly): Last -874K.
13:00 - Ten Year Note Auction: $32B.
The Fed (All Times Eastern)
10:00 - Speaker: Federal Reserve Chair Jerome Powell.
14:00 - Beige Book.
Today's Earnings Highlights (Consensus EPS Expectations)
Before the Open: (CPB) (.74)
After the Close: (MDB) (.07)
