The Fed is really serious now

Stocks fell yesterday on hawkish comments from Fed Chair Jerome Powell. Bond yields rallied pandemic era highs in the wake of Powell’s hawkish words.

Snap back to reality, ope there goes gravity – You know how that goes. After a brutal couple of months in the markets, we get an aggressively bullish couple of days. You wake up every morning and say, “this can’t last, I am sure that the markets will be down,” but, in fact, they are up again. You are happy but pensive. Just yesterday, I offered a reason for last week’s market jump, the largest since sometime in 2020. Markets have already factored in the financial fallout from the Ukraine crisis, crude oil prices have simmered down, and now we know what the Fed is planning over the next 18 months or so and it was roughly what the market was expecting. Seemed like a good time to buy some favorite tech stocks which were on sale after a 3-month rout. That explanation seemed sound and lasted for all of, say…2 hours. You know how this story ends.

Chairman Powell spoke at the NABE Conference yesterday and in his Q&A session he kind of, hinted that a +50 basis point hike might be in the works. Add that to an already aggressive inflation fighting speech, and the crowd moved forward on their seats. When questioned what would prevent the Fed from tightening by +50 basis at the next FOMC meeting, the chairman simply responded with the word “nothing”. Ok, no news service was willing to let that hot bun get cold. The second the news that a +50 basis hike might be in the offing, the algorithms and ultimately everyone else began to sell stocks…and bonds. Two-year Treasury note yields ran up by +19 basis points in the wake of yesterday’s comments. For some perspective, that is an oversized daily move for the 2-year.  Ten-year Treasury note yields added +14 basis points, which is also a big move for the benchmark issue. If you’d been paying attention to those numbers, you would have realized that the yield curve between 2-year and 10-year maturities flattened by -5 basis points. That spread is now at +16 basis points, right around where it was just before the pandemic. You may recall that the Fed was in easing mode at the time, attempting to stave off a potential recession. A recession would ultimately come in 2020, but it was clearly due to the COVID lockdown. So, the 2-year/10-year yield curve is where it was when the Fed was last easing monetary policy and now the Fed is embarking on an aggressive tightening cycle.  That surely has some folks on edge, and it certainly explains why volatility remains high.

Back to Powell’s +50 basis point hike. First of all, we need to read his exact words. He said that the Fed was prepared to hike by +50 basis points…if necessary. Well, of course we knew that.  Anything new? Remember that the Fed bestowed upon us its Dot Plot last week, which showed that it expected, on median, that Fed Funds would be just under 2% by the end of the year. People have assumed, because there are 6 remaining meetings for 2022, that the Fed would raise rates by +25 basis points per meeting. That is pure assumption. There is nothing stopping the Fed from raising rates by +50 points in the next meeting (May 4) and skipping the June 15 meeting…or all possible permutations through the end of the year. The big question is, does it really matter? Many believe, the Fed included, that a 2% Fed Funds rate is neutral. That means it is neither stimulative nor restrictive. Therefore, it is reasonable that the Fed would want to get to that level as soon as possible to have optionality. The option to move quickly into the restrictive zone if inflation does not recede, or to move rates down if the economy begins to falter. Last Friday, Fed Funds futures put a 44% probability of a +50 basis point rate hike in May. After yesterday’s comments, that probability went to 64%. Fed Funds futures predict that Fed Funds will end the year at 2.25%...same as prior to Powell’s comments. 

YESTERDAY’S MARKETS

Stocks sold off on hawkish comments by Fed Chair Jerome Powell. Markets were already under pressure from rising crude oil prices which climbed by some +7% for the session. The S&P500 slipped by a narrow -0.04%, the Dow Jones Industrial Average fell by -0.58%, the Nasdaq Composite Index pulled back by -0.40%, the Russell 2000 Index dropped by -0.97%, and the S&P500 ESG Index gained +0.13%. Bonds fell and 10-year Treasury Note yields gained +14 basis points to 2.28%. Cryptos declined by -1.08% and Bitcoin slid by -0.41%.

NXT UP

• Richmond Fed Manufacturing Index (March) may have increased to 2 from 1.
• More Fed speakers:  Williams, Mester, and Daly.
• Adobe will announce earnings after the closing bell.