You play tricks on my mind
You're everywhere, but you're so hard to find
You're not warm or sentimental
You're so extreme, you can be so temperamental
- "Urgent" (excerpt) Mick Jones (Foreigner), 1981
Elevator Music
Minutes from the Fed's meetings are published with a three week lag. The minutes are really just a summary of what was discussed at the meeting where the most recent policy decision was made. Markets have already absorbed that decision and the subsequent press conference where the Fed Chair explained to the financial media what the committee (FOMC) is doing and where they think they are going. In other words, the Fed minutes rarely surprise anyone, and therefore, are not usually a market-moving publication. Well... so much for that.
We had already known that the FOMC had started to accelerate the tapering, or the withdrawal of the central bank's balance sheet expansion program known as "quantitative easing." We had already known that the Fed's infamous dot plot showed that, as of the December meeting, the Fed is expecting to increase short-term interest rate targets three times in 2022, and in the land of teddy bears, candy canes and licorice, three more times in 2023 and twice more in 2024.
Shots Heard Around The Street
Then, Fed Governor Christopher Waller shook a few cages when he suggested that the March (15th & 16th) meeting, which is the same month that the tapering could be completed at its current pace, might be live, as far as interest-rate flexibility is concerned. The game had started to change.
Balance sheets were important. Cash flows are a focus. Profit margins are really, really important. Growth was cool. Still will be. Growth without profit, far less so.
The PCE price index, the one that our central bank's long-time 2% inflation target is tied to, printed at headline year-over-year growth of 5.7% for November, 4.7% at the core. December data will not hit the tape until Jan. 28, but using the CPI as a guide, December should be worse. The Fed's forward-looking economic projections, published along with that December policy statement, show a central belief across the group that consumer-level inflation will average 4.4% for 2021, before falling back to a much more publicly palatable 2.7% for 2023. Markets, however, sense a lack of trust at the FOMC in their own projections.
Back to those minutes. Some participants suggested that the Fed might raise short-term rates before maximum employment is even achieved. What is maximum employment? Janet Yellen never knew. How can Jerome Powell? Think Sasquatch. Many believe, many think they might have caught a glimpse. That said, nobody ever really got a good look, or found actual proof.
Then, the shot that surprised the marketplace was fired. "Many participants judged that the appropriate pace of balance sheet runoff would likely be faster than it was during the previous normalization episode." Bang. Quantitative Tightening.
Old kids, bear with us. New kids... the Fed holds nearly $9T worth of Treasury securities and mortgage-backed securities (that I have been publicly asking it to stop buying for a year now) on its balance sheet. The accumulation of these assets has increased the monetary base, and thus overall liquidity. That, in turn, had placed a bid under risk assets, and placed a fire under both producer and consumer-level inflation once problems in supply chains and shortages in labor markets produced a spark. This despite a slowdown in velocity as expressed in ratio terms as a percentage of money supply.
If the Fed was more worried about financial market disruption, and less worried about inflation, then the Fed would reinvest maturing securities in these markets. If the Fed is more concerned with inflation than disruption across financial markets, then the Fed will allow maturing securities to roll off of the balance sheet, and try to, as quickly as possible, shrink the monetary base -- and to soak up excess liquidity.
What Now?
My guess is that the central bank will start out with some kind of split between reinvestment and roll-off that will, in measured movement over months, decrease reinvestment and increase the roll-off. Oh boy, a new kind of tapering. This trend will persist until both inflation is brought down to an acceptable level, and either the balance sheet reaches a predetermined level, or something actually breaks. That something would be sustainable economic growth.
As I look over all of the data left behind by Wednesday's run for the exits (and assuming that all rate hikes would be limited to 25 basis points, which is no sure thing) I see that futures markets trading in Chicago are now pricing in a 68% probability of a first hike for the Fed Funds Rate in March, a 67% chance for a second hike in June, a 55% chance for a third rate hike in September, and an almost 50/50 shot at a fourth rate hike by December.
Of course, there is a lot of wood to cut between now and then and as they say in the infantry: "Everyone has a plan until making first contact."
What? You thought Mike Tyson's adaptation of that quote was the original? That's adorable. It was Prussian General Carl von Clausewitz who said, "Every plan is a good one, until the first shot is fired." Clausewitz died in 1831. Some form of that sentiment has been in circulation ever since.
Equity Markets
Wednesday got bloodier the further out on the spectrum of risk one traveled. While the Dow Industrials "only" surrendered 1.07%, the Transports backed up 1.42%, while the S&P 500 gave up 1.94%, and the Nasdaq brothers (Composite & 100) spit the bit for an ugly 3.34% and 3.12%, respectively. The S&P 500 gave up the 21-day exponential moving average (EMA), while the Nasdaq Composite quickly retreated from its 50-day simple moving average (SMA), without putting up a fight. We did produce that heads up here in this space 24 hours ago.
All 11 S&P sector-select SPDR ETFs closed in the red, with Materials ( ( XLB) ), Energy ( ( XLE) ), Utilities ( ( XLU) ), and Staples ( ( XLP) ) all hanging very close to "unchanged." Once again, steel stocks such as Cleveland-Cliffs ( CLF) and Nucor ( NUE) were simply spectacular places to be as the world melted. Conversely, Communications Services ( ( XLC) ), Discretionaries ( ( XLY) ), Technology ( ( XLK) ) and the REITs ( ( XLRE) ) all pedaled backwards anywhere from 2.5% to 3.25%.
Within tech, the Philadelphia Semiconductor Index lost 3.2%, while the Dow Jones U.S. Software Index was simply hit with "the ugly stick" at -4.5%. Quite interestingly, as these two industries have been forced together, but perhaps do not belong together, within Communication Services, the Dow Jones U.S. Internet Index , which used to be part of tech, gave up 4.5%, while the Dow Jones U.S. Mobile Telecommunications Index (which used to be its own sector, and a defensive sector at that) actually gained 1.1% for the session.
Wanna take a stab at equity market breadth? Well, losers beat winners at both the NYSE and the Nasdaq by about 9 to 2. Aggregate trading volume was heavy, though down small for names domiciled at the Nasdaq from Tuesday. That could be a silver lining, as the lack of increased volume could ultimately present as a lack of commitment to the current selloff.
I did add to Zscaler ( ZS) , and ServiceNow ( NOW) on Wednesday. I also traded out of and back into Salesforce ( CRM) which actually worked well. No promises.
Advancing volume comprised 23.9% of the NYSE composite, and 21.5% of the Nasdaq composite (volume, not index).
Treasury Markets
The U.S. 10-Year Note pays as much as 1.735% this morning. You may recall that this product paid just 1.5% on New Year's Eve. The U.S. 2-Year Note has been selling off more quickly than the 10-Year and gave up 0.83% by last night. The 2-Year now gives up 0.87% early this morning. The 90-day, or 3-Month T-Bill has largely remained at least a little more anchored than the belly of the curve, and pays a little more than nine basis points as I bang out this note.
In other words, while the yield for the U.S. 10-Year Note has done this:
The yield spread between the 10-Year and 2-Year has done this:
But the spread between the 10-Year and the 3-Month has done this:
So far, and it's early, we are still in the planning stages, we haven't been hit in the mouth or made first contact with the enemy just yet, the tea leaves are not saying recession. No single Treasury security series has inverted with the next series out. That said, the market may be preparing itself for a much tougher environment that if not met with the necessary level of finesse, could be somewhat lengthy.
I would say that this is no time for an aggressive Fed, but when might be a good time to normalize rates, and shrink an almost $9T balance sheet? If not a time where consumer-level inflation is uncomfortably hot and at least for the quarter, growth is elevated, then when? The time for the central bank to make that effort is now. They know it. You know it. I know it... and they are scared.
The Rules of the Game
Doesn't matter if you are trading these markets, raising a family, carrying a rifle in the jungle, or trying to deal with personal, family or health issues. I have found that a set of rules that I adapted many years ago as a sort of standing five-paragraph order, has always helped. At least for me.
I have been asked, through multiple requests since last night, to remind the good folks. Let us proceed. As one. Together we turn and face the day. Together we rise. Together we fall. Together, is the only way.
1) Understand - The environment is what it is. Individuals can not change the big picture. Individuals are, however, far from helpless. Be pragmatic. Anticipate. If unable to anticipate, then recognize trend.
2) Identify - See both threats and opportunities in real time. Know your abilities and your weaknesses as you know your life. Know your tolerance. Recognize avenues of approach. Determine what, where and when.
3) Adapt - Set up incorrectly? Didn't have all the information? Easier to change that environment or easier to change yourself? Be amphibious. Thrive regardless. Embrace the pain. Always strive to learn. Everyday. Like any muscle group, cognitive ability can atrophy before its time. Be better today than yesterday. Be better this afternoon than this morning.
4) Overcome - Set goals. In markets, we call them price targets and panic points. Self-discipline is code. Live by code. Consistency in effort. Failure with a lesson retains value. Defeat without interpretation becomes habit. No excuses for that.
5) Maintain - Level head. I am not, and you are not as smart as we think we are in victory. Nor are we as foolish as we see ourselves in defeat. Always act for a reason. Always be able to simplify that reason in such a way that a novice could follow. Carry on with the mission. Be ever vigilant.
Economics (All Times Eastern)
08:30 - Initial Jobless Claims (Weekly): Expecting 203K, Last 198K.
08:30 - Continuing Claims (Weekly): Last 1.716M.
08:30 - Balance of Trade (Nov): Last $-67.1B.
10:00 - ISM Non-Manufacturing Index (Dec): Expecting 67.0, Last 69.1.
10:00 - Factory Orders (Nov): Expecting 1.4% m/m, Last 1.0% m/m.
10:30 - Natural Gas Inventories (Weekly): Last -136B cf.
The Fed (All Times Eastern)
No public appearances scheduled.
Today's Earnings Highlights (Consensus EPS Expectations)
Before the Open: BBBY (.02), CAG (.68), STZ (2.83), HELE (3.16), WBA (1.32)
After the Close: PSMT (.91), WDFC (1.25)
