Stocks fell for a second straight session after FOMC meeting minutes confirmed what investors feared: the Fed will sell bonds as early as next month. The news led to higher yields on longer maturity Treasury securities which put further pressure on growth stocks.
Can you hear me now? What is the first thing you think about when you pay your bills. I mean after you realize that you spend too much money and that you need to make more income. Do you think “darn, those 25 extra basis points on the Fed Funds Rate is really hurting?” No, of course not, because the +25 basis points do not really have an impact on your monthly budget. Now, you are surely saying to yourself “what are you talking about Mark, the Fed just raised rates to tackle the worst-in-40-years inflation, and they are not the kind of folks who mess around!” Sorry to disrupt the understandable, but common misunderstanding. You see, in banker talk there is something known as the neutral rate. If you really want to use geeky-banker-economist talk, you could call it R*, which is pronounced “r star”. That is the Fed Funds Rate, which is neither accommodative nor obstructive to economic growth, in other words, neutral. Well, as you might guess, there is lots of debate over what that rate actually is. Most believe that R* is somewhere between 2% and 2.5%. That said, the Fed will have to get Fed Funds beyond that zone before the hikes can really have a meaningful impact on demand and subsequent inflation. So, while a +25 basis point hike seems like we are making progress, it is really just a formality. Besides, have you ever borrowed money at the Fed Funds rate? Of course, not…unless you are a bank borrowing money from another bank…overnight. Now that you know all of this, you probably understand why Fed governors have been quite vocal about speeding things up on the hiking program. I don’t want you to believe that a +25 basis point hike has absolutely no negative impact on consumption. It actually does, but indirectly. When consumers hear about the Fed hiking, expectations for higher costs and a slower growing economy cause consumers to lose confidence and, perhaps, pull back on their spending, ultimately slowing inflation. The Fed is hoping that this will happen. Kind of like when your parents would say “don’t make me pull this car over.” Of course, they didn’t want to.
While the world is hyper focused on the Fed Funds Rate, it should really be more concerned about the Fed’s balance sheet. Remember quantitative easing? The Fed was buying some $150 billion in Treasury and mortgage-backed securities for the better part of the pandemic through last month. At some point, we know that the Fed will have to shrink its holdings for 2 primary reasons: 1) good housekeeping – refill the coffers in case another economic hiccup occurs, and 2) to take money out of the economy and tighten credit conditions to fight inflation. The Fed can shrink its balance sheet by either simply letting bonds mature or by actively selling them in the open market. The former does not have a big impact, while the latter will certainly leave a mark. Ok, ok we were expecting it…later in the year perhaps, possibly as early as mid-summer. Well, 2 days ago, well-known dove Fed Governor Lael Brainard signaled to us the Fed was likely to start running off its balance sheet next month. Yesterday’s FOMC minutes released from the Fed’s March 16th meeting confirmed what we expected on rates and what Governor Brainard told us. The Fed is likely going to raise rates by +50 basis points at its May gathering, and that it would have likely raised rates as much in its last meeting but for the war in Ukraine. ADDITIONALLY, the Fed is likely going to begin shrinking its balance sheet by as much as $95 billion per month. For some context, the Fed’s last quantitative tightening in 2017 gradually raised the ceiling from $10 billion to as high as $50 billion per month, so this time around, not surprisingly, the Fed is acting a bit more…aggressively. As aforementioned, some of the runoff will occur naturally by simply allowing bonds to mature, while the remainder will require the Fed to literally hit open market bids. That selling pressure can push bond yields higher, which would certainly have an impact on your monthly mortgage payment, auto loan payment, or credit card payment. So, next time you sit down to pay your bills, contemplate the reality that your costs are going to go up, not because the Fed Funds rate is slightly higher, but because the Fed is selling bonds.
WHAT’S SHAKIN’
Hewlett Packard (HPQ) shares are higher by +13.72% after a Form 4 filing revealed that Warren Buffet invested some $4.2 billion in the computer maker. At yesterday’s close, the stock had lost -6.67 year to date. Dividend yield: 2.86%. Potential average analyst target upside: +8.4%.
Ford Motor Co (F) shares are lower by -1.55% in the pre-market after Barclays downgraded the stock to EQUALWEIGHT. In the past month, 30% of analysts have modified their price targets, 0 up, 7 down, 15 unchanged, and 1 dropped. Dividend yield: 2.6%. Potential average analyst target upside: +36.6%.
YESTERDAY’S MARKETS
Stocks gave up ground yesterday as FOMC minutes revealed just how serious Bankers are about fighting inflation…um, shrinking its balance sheet. The S&P500 fell by -0.97%, the Dow Jones Industrial Average gave up -0.42%, the Nasdaq Composite Index sank by -2.22%, the Russell 2000 index sold off by -1.22%, and the S&P500 ESG Index lost -1.17%. Bonds gave up ground and 10-year Treasury Note Yields climbed by +5 basis points to 2.59%. Cryptos dipped by -6.66% while Bitcoin gave up -4.32%.
NXT UP