Signs of pain ahead are racking up

Stocks had a bumpy ride yesterday after a hotter-than-expected employment figure and less aggressive talk from Powell. The yield curve is flashing signs of panic – does anyone even care?

Obfuscation. The Fed intentionally sends messages to the market. I cover this topic often in my notes. It is all part of my plan to get the message across “don’t fight the Fed!” In my experience, the Fed rarely makes moves contrary to what it says and it very typically, especially more recently uses the market to guide it. The whole idea behind the backchannel communication and feedback loop is to a) avoid spooking the financial markets / banking system, and b) let the market do the dirty work. If the market is convinced that interest rates must go higher, rates… well, typically will go higher before the Fed even makes a policy move.

Of course, the Fed’s intention is not always crystal clear, but one carefully observes themes and patterns leading up to an FOMC meeting, some clarity on what the Fed will do can be gleaned. In the past several weeks however, the message has not been as clear as one would expect. Just by listening to Powell’s 2 days of testimony, you would have gotten one message on Tuesday: +50 basis points of hikes later this month, and another one on Wednesday: maybe not +50 basis points of hikes. The market gives the +50 basis-point move a 68% chance of occurring, higher than yesterday by a bit… if you were paying attention.

The market, through futures and overnight index swaps is sending a message to the Fed: “it is kind-of OK if you raise rates by +50 basis points.” We more affectionately refer to that as the “market has it baked in.” But there is another message that the market is sending, and no one, not even the Fed, seems to be getting.

The yield curve is flashing a blaring warning sign. It is saying “enough already, tread lightly warrior bankers!” The yield curve between 2-year Treasury Notes and 10-year Notes is -105 basis points! That is not only inverted, but as the younger set would say, “that’s hella inverted.” In fact, it has not been this inverted since 1981. Seems like yesterday, but it was a long time ago. As you will see from the chart below, each time the yield curve inverted a recession followed. As 2-year yields continue to rise along with the Fed’s expected aggressive policy, 10-year yields remain constant or lower, as traders expect trouble for the economy. Those 10-year traders have good reason to expect trouble, as it was made quite clear in this finishing-up earnings season. Companies are expecting a lean 2H and it is reflected in earnings estimates which show 2 quarters of earnings declines, AKA, an earnings recession.

The Fed, obviously, would like to avoid that, but it seems that the bankers feel that a recession may be the necessary, bitter medicine to get rid of inflation. They may be right, but the question remains, just how much pain must the Bank inflict and how fast before the medicine takes effect? Based on the Fed’s recent ambiguity, it seems that the smartest bankers the world over are a bit in irons over that question as well. All we can do is watch the numbers and pay close attention. The Fed has clearly placed a lot of import on the labor market, which has been, unarguably, running hot. Yesterday’s job openings numbers and hotter-than-expected ADP Job Additions number confirm that. There are plenty of vacancies, and companies are still hiring. Tomorrow’s government release will be the one to watch. The Fed economists will read the same report as you and me tomorrow morning at 8:30 AM Wall Street Time. You know what that means, right? A hotter number will send the bulls into hiding as yields climb, and vice versa for a weaker growth figure.

WHAT’S SHAKIN’

SVB Financial (SIVB) shares are lower by -30.46% in the premarket. The company announced a $1.25 billion stock offering along with a sale of $21 billion in securities to shore up its balance sheet. The surprise announcement also came with guidance that the sale will result in a $1.8 billion after-tax loss for Q1. Potential average analyst target upside: +6.3%.

Signature Bank / New York NY (SBNY) shares are down by -11.47% in the premarket. This is the second time in as many days the SBNY has appeared in my note. The bank has a large exposure to digital assets (AKA cryptos), and the recent unwinding of Silvergate Capital (SI) has exposed the bank’s valuation to questions. Dividend yield: 2.70%. Potential average analyst target upside: +40.5%.

YESTERDAY’S MARKETS

Yesterday, equities bounced about as the market factored in a hot labor number and slight softening in Powell’s hawkish tone. The S&P500 inched higher by +0.14%, the Dow Jones Industrial Average slipped by -0.18%, the Nasdaq Composite Index advanced by +0.40%, and the Russell 2000 Index added +0.04%. Bonds fell and 10-year Treasury Note yields climbed by +2 basis points to 3.99%. Cryptos fell by -0.47% and Bitcoin lost -0.22%.

NEXT UP

• Initial Jobless Claims (March 4) is expected to come in at 195k, slightly higher than last week’s 190k claims.
• Fed speakers: Vice Chair Michael Barr will speak about crypto. You can watch it here:  https://www.youtube.com/user/PetersonInstitute
• After the closing bell earnings: Ulta Beauty, Oracle, DocuSign, Vail Resorts, and The Gap.