Good Tuesday PM,
Doing a little cheating today as it’s already late, so using a good bit from Dan Rawitch and a good piece from Bloomberg. The point of all of it is that temporarily bonds and rates are in rough shape after Mr. Powell dropped the mic on several more rate hikes of potentially 50bps each. I am sure he was hoping to create some spread in the short term vs long term rates but that didn’t happen. The yield curve just gets flatter and will invert shortly pointing to a recession. That is what we call unintended consequences.
I am thinking back to every Fed we have had in my lifetime and every rate tightening cycle I have been through and I cannot recall a single time where a Fed has gone out of their way to spook the markets. I am speculating but, if you listen to Powell, you have hard time disagreeing with me. He wants to let air out the bubble in both fixed and equity markets. Deflating the bubble will stop consumer spending and ultimately bleed out inflation. The problem is that inflation will likely not peak until oil does AND the supply chain normalizes. Crashing the markets may ultimately control inflation but the damage to many people could take years to repair. Powell’s words have hurt MBS bonds to the tone of well over 150 basis points in price. He is now suggesting that 50 bp increases will be better. We are in uncharted waters and I urge you to play defense and keep things locked. As I mentioned over the last couple of weeks, things may get worse before they get better.
For a long time there was this notion of a “Fed Put” — basically the idea if the stock market fell too much, then we’d get rate cuts or other easing that would stabilize things.
But this dynamic hasn’t been in play for a long time now. With inflation running well above target, and at multi-decade highs, it would take a lot for the Fed to worry about a stock market selloff. In fact, this has been demonstrated. Stocks have fallen substantively from their highs, yet the Fed went ahead and hiked rates last week and made clear that it intends to hike several more times over the coming year.
But now there’s another possibility. Maybe we have a “Fed Call.” Maybe the Fed is downright uncomfortable with stocks going up here.
Last week, in addition to the Fed’s rate hike, we got a soaring stock market. The S&P gained 6.2% on the week. The NASDAQ-100 gained more than 8%. In an op-ed in the Washington Post, Larry Summers warned that the market was wrong to rally so hard in response to the Fed. Or, to put it another way, he warned that the market’s bullish response to the Fed was de facto evidence that Powell & Co. are still being too easy — not taking a hard enough line on inflation.
Yesterday we heard from Powell again, and everyone seemed to think he sounded considerably more hawkish than he did the previous week. In a note to clients, Omair Sharif of Inflation Insights noticed some substantive differences between his comments last week and his comments yesterday, particularly around the degree to which inflation would fall on its own due to non-monetary factors.
Going back to last week for a moment, there was an interesting question from Bloomberg economics reporter Rich Miller about financial conditions, and whether a tightening of conditions (through lower stock prices, higher credit spreads and higher bond yields) was a welcome development. And basically Powell’s answer was that yes, monetary policy works through financial conditions, and so tighter financial conditions are the means via which the new policy stance will constrain inflation.
So here you have the Fed hiking last week, but financial conditions easing dramatically thanks to the huge surge in the stock market. And then yesterday you have Powell coming back, taking a seemingly more hawkish tone. Perhaps what it means is that the Fed Chair agrees somewhat with that Larry Summers op-ed: that the stock market surge was not in accordance with what the Fed is going for here, that it doesn’t want to be seen as just hoping for inflation to roll over, and that it wants to be active in making sure this period of high prices is stamped out.
Of course, the S&P finished yesterday basically flat after having been down nearly 0.9% at one point. So if Powell did intend to express discomfort with the rally, or at least convey something new to the market, it didn’t ultimately go very far.
Please remain safe and healthy.