Thin Ice

Thin ice.  Stocks ended yesterday’s session lower as investors pondered weaker-than-expected retail sales figures.  The Fed meeting, which will conclude today, was on everyone’s mind, and traders appear to be preparing for the worst.

N O T E W O R T H Y

Seeing dots before my eyes. You take your spot on the stage. You can hear the low, but forceful murmur of the packed house on the other side of the curtain.  You take a deep breath as the curtain rises.  The white-hot spot light beams down on you, and you can feel its heat on your face. Suddenly the audience is dead silent, all focused on you, awaiting that first note.  That first note, which will set the pace, the mood, and the color of the remainder of the show.  No stress… but you better get it right, or the next 2 1/2 hours could end up being… well, not too enjoyable.  You, in this case, are Federal Reserve Bank Chairman Jerome Powell.  

The economy is roaring back, prices are on the rise, and sentiment is improving.  The economic recovery from last year’s once-in-a-generation calamity was largely sponsored by the Fed.  Let’s get more exact and say that the economic stock market recovery was underwritten by the Fed.  The Fed has not only set key interest rates to 0%, but they have also been actively purchasing bonds to keep prices propped up and yields low.  The thought of those training wheels coming off causes a bit of discomfort, with last year’s market selloff still fresh in the minds of investors.  Once it became clear that vaccines would enable life to begin to return to normal, markets turned their focus on the Fed’s monetary stimulus and they began to ponder when it would end.  We have been here before. It seems like it was just yesterday when the same fears gripped markets after the last recession.  It was May of 2013 when then Fed Chair Ben Bernanke announced that the Bank would be tapering its bond purchasing pace.  The result of the announcement was met with a bond market selloff which saw 10-year treasury yields spike by +100 basis points over the roughly 2 months that followed.  That selloff in bonds got a name: The Taper Tantrum. We find ourselves in a similar position today where traders know that the music has to stop eventually, but are unsure about when it will actually end.  The Fed has called the recent spike in inflation transitory while pledging to keep stimulative provisions intact for an extended period. Both comforting on the surface, but lacking true substance, due to their undefined timeframes.  We can search for some clues and attempt to narrow down the timeframe by examining the language of FOMC members in their numerous public appearances.  While FOMC members continue to toe the line, some members appear not quite hawkish but, perhaps a bit less dovish.  That may mean that they are willing to consider rate hikes earlier than originally projected. We may be able to see some of those changes in sentiment appear in today’s dot plot release. The dot plot shows Fed member projections for interest rates through 2023 and beyond.  Each dot represents an individual member’s projection and the median is used as a policy projection.  In the last release from March, the median projection for the end of 2023 showed Fed Funds remaining unchanged around 0%, only rising in the “longer term” beyond 2023.  The individual dots show that 7 members expect rates to be higher, with the remaining 11 member majority expecting no change.  The last release also reflected that 4 out of the 18 members expected rates to be higher by the end of next year. For today’s release, it would take only 3 members to change their 2023 projections to change the rate liftoff date into sometime in 2023 as opposed to “sometime beyond”.  This would send the market a clear message of “sooner rather than later”, and given recent slight changes in some governors’ body language, a shift is certainly in the realm of possibilities.  As mentioned in yesterday’s note, investors will be interested to learn if or when the Fed will begin to discuss tapering bond purchases.  To be clear, the Fed is largely expected to keep policies unchanged at this meeting.  It is the nuances in the statements, the press release, the dot plot, and the economic projections that will be carefully scrutinized today.  Of course, many of these types of non-numeric indicators are subject to interpretation, which leads to a differing of opinions, which ultimately is likely to lead to near-term volatility.  It is important to note 2 things.  First, Fed Funds Futures have already factored in a +25 basis point hike in 2022 and another +25 basis point hike in 2023.  Second, 10-year bond yields have already risen by some +100 basis points since late last summer. That jump in yields is roughly the same response to the 2013 taper tantrum.  A side note on that.  Though growth stock investors have zeroed in on bond yields as of late, the 2013 taper tantrum had little or no effect on the growth-heavy Nasdaq, which added +26% from the tantrum through the end of that year.  Will markets react differently this time?  It is hard to tell given the different circumstances today. We can count on one thing.  The lead actor in today’s show, Chairman Powell, will have to hit every note in perfect pitch and timing to avoid the possibility of any sort of emotional outbursts.

THE MARKETS

Stocks traded lower yesterday in response to weak economic data and trepidation about the results of the FOMC meeting, out today.  The S&P500 fell by -0.20%, the Dow Jones Industrial Average slipped by -0.27%, the Nasdaq Composite Index dropped by -0.71%, and the Russell 2000 Index gave up -0.26%.  Bonds slipped and 10-year treasury yields were unchanged.  Cryptos slipped by -0.52% after rallying on Monday in response to positive comments by Elon Musk over the weekend.

NXT UP

– Housing Starts (May)  are expected to have increased by +2.9% after falling by -9.5% in the prior month.

– Building Permits (May) may have slipped by -0.2% after falling by a revised -1.3% in April.

– The FOMC Policy Decision will be released at 2:00 PM EST and followed by the Chairman’s press conference.