One down... two to go.
Day one of our three-day financial market gauntlet has passed. For all of the hype around the event, the March release of the Consumer Price Index passed without causing all that much damage. There were some not-so-pleasant surprises in that release, but also some visible progress. Treasuries and equity markets both rallied upon that news, at least at first. But not for long as bond traders sold Treasuries from the belly of the yield curve out to the long end rather quickly. They would make the round trip more than once on Wednesday.
Equity traders, however, hung in there pretty well. There was a rally on Wall Street that survived the semi-sloppy auction of $32B worth of 10-Year Notes at 13:00 ET, only to fall victim to the Minutes of the FOMC policy meeting of March 22. Often the Fed Minutes, given that they are dated (three weeks old) pass with just a glance and not that much more. This time, they turned the stock market against itself. At least for this one afternoon.
Day Two is the lightest of our three-day gauntlet. That does not mean that danger does not hide out amongst us, though. March year-over-year PPI is expected to show some serious disinflation at both the headline and the core. It had better. In addition, the weekly jobless (and continuing) jobless claims will have an impact as the past two weeks have seen initial claims start to wobble. The constant growth in continuing claims has been this economy's dirty little secret for several months now.
We'll worry about day three on day three with all of its GDP moving macro and banking earnings. Those banks alone and what they have to say about their current realities might just be the event of the season.
March CPI
At first glance, the numbers show significant progress at the headline level. Huzzah! On a month-over-month basis, headline CPI grew just 0.1% in March, down from 0.4% in February and 0.5% in January. On a year-over-year basis, which is the primary way that most economists look at inflation, the headline rate showed 5% growth, which was below the expected 5.2% and well below February's 6% print and January's print of 6.4%. In fact, March was the ninth consecutive month that headline consumer-level inflation showed improvement from the prior month.
Here's where this "victory" gets a little messy. Much of the improvement was made due to Energy prices that (all components included) showed a month-over-month decrease of 3.5% and a year-over-year decrease of 6.4%. Gasoline prices were down 4.6% m/m and 17.4% y/y. That helps a great deal. This, however, has no impact on core inflation. Food prices were flat month over month, while food at home actually saw a 0.3% month-over-month decrease. Food prices are still up 8.5% y/y, but food helped pressure consumer prices in March. Food also is not part of core CPI.
Core CPI, as we had always expected and feared, will be stickier than headline CPI. At the core, CPI showed month-over-month growth of 0.4%, which was in line with expectations and a deceleration from 0.5% growth in February. On a year-over-year basis, Core CPI inched higher to 5.6% (which was expected) from February's 5.5%. This pace of annual growth is equal to the pace of January and down only slightly from 5.7% growth in December. In short, Core CPI on a year-over-year basis has largely flat-lined for four months.
While not out of the blue, this reality concerns economists, as Shelter, which we know is dated, and has appeared to have finally turned a corner, continues to put upward pressure on the index. March Shelter was up 0.6% m/m and 8.2% y/y. Perhaps the most persistent component placing upward pressure on core prices has been transportation services, as folks continue to come back to the office after working from home for months or even years. These services were up 1.4% m/m in March and up 13.9% year over year. All as used car prices continue to fall.
The problem is that while food prices may have been contained for now, we all know that energy prices have rallied in April. That's your heating oil. That's gasoline. Sure, blame OPEC+ if you want. The price is still going to be the price. Higher prices at the pump, as we know, impact everything, including food.
April is not over, but April is not looking so pretty right now. Currently, the Cleveland Fed's Nowcasting model shows April CPI likely to print at +0.54% m/m and +5.12% year over year, with the core printing up 0.46% m/m and +5.56% y/y. If that's how April trends as the economy slows, just how do you think the FOMC will vote on May 3? April CPI does not hit the tape until May 10.
FOMC Minutes
So, why did these Minutes have a greater impact on financial markets than the above-mentioned CPI data? Easy. These Minutes scared the stuffing out of some traders, or at least forced the keyword-reading algorithms that represent these traders in the modern era to hit bids successively on Wednesday afternoon.
There was one line that stood out that traders and their software picked up on: "The staff's projection at the time of the March meeting included a mild recession starting later this year, with a recovery over the subsequent two years." If banking and financial conditions were to deteriorate more than assumed, then risks around baseline expectations would be skewed to the downside for both economic activity and for inflation. (Duh)
Ahead of the regional banking crisis in March, several participants had seen appropriate interest-rate policy as being somewhat higher than where it had been. Several participants agreed that there was little evidence reflecting disinflationary conditions for core services ex-housing.
On a bright note, several among the group emphasized the need to remain flexible and retain optionality, but also noted that the longer inflation remains well above target, the more likely that inflation expectations become un-anchored.
In short, at least as of three weeks ago, the Fed in general felt that while they had to be more gentle in tightening monetary policy than they had been, they must still tighten. Even if that means taking the U.S. economy into recession. Yes, at this point even the Fed staff projects recession.
There can now be no feigned surprise when it happens. This will not be some "pretend" unintended consequence. Without saying so (my opinion), it appears that the FOMC is quite willing to use a contraction in U.S. economic activity as a tool that will not just slow demand, but force unemployment back to levels once considered more than acceptable (but painful from here) as a means toward an end.
Point, Counterpoint
On the same day that we learned that Fed staffers had (for the first time this cycle) already warned the FOMC of a pending, but nearly imminent recession that could take two years to recover from, there were dueling Fed heads out and about.
Richmond Fed Pres. Tom Barkin said:
"I certainly think we are past peak on inflation, but we still have a ways to go. There's still more to do I think to get core inflation back down to where we'd like it to be."
San Francisco Fed Pres. Mary Daly said:
"Looking ahead, there are good reasons to think that policy may have to tighten more to bring inflation down, but there are also good reasons to think that the economy may continue to slow, even without additional policy adjustments." Daly added, "If we force an unnecessary contraction, that hurts the very people we're trying to assist by bringing inflation down."
Neither Richmond nor San Francisco vote on policy in 2023. Both will regain their vote in 2024.
Fed Funds Futures
After all of that, but ahead of this morning's March PPI print, Fed Funds futures trading in Chicago are pricing in a 69% probability for a 25 basis point rate hike on May 3. This will bring the target for the Fed Funds Rate up to 5% to 5.25%, which is still what these markets see as the terminal rate.
This market is also pricing in a 65% likelihood for a first rate cut on July 26, with a target range (66% probability) of 4.25% to 4.5% by year's end.
Markets also see the Fed Funds Rate at 2.75% to 3% within 18 months' time as the Fed is forced to deal with the recession it helped create first as the enabler of reckless fiscal policy, then as it was slow to react to changed economic realities and then finally as it overreacted in compensation for having been lethargic at first.
Marketplace
Equity market indexes closed the day painting a tape red that had been green, even nicely green for most of the session. While there was no huge displacement, with the exceptions of the semiconductors and some discretionaries, the turnover at less than two hours elapsed was remarkable.
Yields from the belly of the curve on out closed with some minor compression for the day. It would appear that Treasury securities have held those gains overnight. The U.S. dollar responded to Wednesday's events with a weakness that propped up prices for gold, silver, oil and Bitcoin.
As for our beloved equity market, seven of the 11 S&P sector SPDR ETFs ended the day in the red, while four posted less than moderate gains. Discretionaries ( XLY) finished the session in eleventh place, led lower by the autos that in turn were led lower by Tesla ( TSLA) at -3.35%.
Communication Services ( XLC) closed out Wednesday in tenth place. led lower by Entertainment stocks, which in turn were led lower by Warner Bros Discovery ( WBD) and Charter Communications ( CHTR) . Those two gave up 5.83% and 4.25%, respectively, for the day.
In ninth place finished Technology ( XLK) , down just 0.57%, but this fund was really split in half. The Dow Jones U.S. Software Index actually showed a gain (+0.06%) on Wednesday, while the Philadelphia Semiconductor Index took a beating of 1.83%. That index was led lower by Applied Materials ( AMAT) , Qualcomm ( QCOM) , and Taiwan Semiconductor ( TSM) , as all three of these names gave up between 2.66% and 2.77%.
I don't know how much breadth can mean on a day with a split personality like this, but losers beat winners by roughly 8 to 7 at the NYSE and by about 7 to 4 at the Nasdaq. Advancing volume took a 36.8% share of composite NYSE-listed trade and a 32.8% share of that same metric for Nasdaq listings. Aggregate trading volume actually contracted (small) for NYSE-listings as well as across the S&P 500. However, aggregate trade increased almost 5% day over day for Nasdaq-listed names. In fact, the Nasdaq Composite has posted six red candles in the past seven sessions, and the one green candle (last Thursday) was by far the most lightly traded session among the seven. Actually, last Thursday, for the Nasdaq Composite, was also the most thinly traded session since the week in between Christmas and New Year's Day.
About Day Three
By the time you read my column on Friday morning, you may very well have already heard from a number of large banks. There will be much to focus on. Probably too much. What matters most this quarter will likely be balance sheet health. Remember that back in February, the FDIC revealed that aggressively higher interest rates last year had translated into $620B in unrealized losses as of the end of 2022.
What will the banks have to say regarding loan growth, or lack thereof? We knew banks were starting to tighten lending standards ahead of the crisis in March. Demand for credit over time had not been all that robust since the fiscal response to the pandemic. That likely changes now, as these lending standards can not ease.
Net interest margin should be interesting. The environment was tough enough. What now, with deposits less stable? All while each and every bank reporting will have to show that they are building up reserves in anticipation of defaults as the U.S. enters into recession.
I don't think you'll hear a lot of specific forward-looking guidance on Friday, or early next week for that matter, but what is said, will move the needle. Expect volatility.
Economics (All Times Eastern)
08:30 - Initial Jobless Claims (Weekly): Expecting 215K, Last 228K.
08:30 - Continuing Claims (Weekly): Last 1.823M.
08:30 - PPI (Mar): Expecting 0.0% m/m, Last -0.1% m/m.
08:30 - Core PPI (Mar): Expecting 0.2% m/m, Last 0.0% m/m.
08:30 - PPI (Mar): Expecting 3.1% y/y, Last 4.6% y/y.
08:30 - Core PPI (Mar): Expecting 3.3% y/y, Last 4.4% y/y.
10:30 - Natural Gas Inventories (Weekly): Last -23B cf.
13:00 - Thirty Year Bond Auction: $18B.
The Fed (All Times Eastern)
No public appearances scheduled.
