Tough Love

Tough love.  Stocks tumbled yesterday in response to a more hawkish than expected rate forecast from the Fed.  Fed forecasts suggest that rates will rise higher and sooner than previous releases, suggesting that the bankers are sensitive to the hot-running economy.

N O T E W O R T H Y

Dotted future.  In yesterday’s note, I highlighted the Fed’s dot plot, as I expected that the governors would use it to send a message to the markets.  The Fed was largely expected to keep policy unchanged, and that they certainly did.  Rates will remain near zero and the $120 billion monthly bond purchases will continue.  So what’s all the fuss about?  There is an old saying that goes “what you don’t know, can’t hurt you.”  I use a lot of Wall Street adages, and that is surely not one of them.  On the contrary, Wall Street does not like surprises, positive or negative. For the markets, it is all about expectations being met, missed, or exceeded.  If the Fed simply surprised us with an unexpected rate hike, the policy move would cause mayhem in an already tense market.  A few days back I reminded readers that the Fed was acutely focused on the equity markets, referred to it as its unofficial third mandate.  Because of this, the Fed has devised all sorts of ways to signal its intent in order to avoid market shocks.  Of course, it is not that simple.  Markets have wised up to the Bank’s ruse and actually responds to those hints as if they were policy, making the delivery of the message that much more critical.  The Fed Chair can’t just say “ya, we are going to raise rates next year, so be prepared. “Instead the Fed needs to say things like, “the economic recovery is progressing quicker than originally forecasted” (not an actual Fed, quote but a good summation of many like it which have been uttered by it in recent month’s).  On inflation, Powell did hint that the Fed’s formerly strong conviction that price spikes are transitory may be softening.  He acknowledged that there is a risk that inflation may persist.  Subtle messages aside, the Fed released its economic forecasts yesterday which upgraded prior GDP growth expectations and bumped up inflation expectations as well.  I probably don’t need to tell you what the Fed typically does when the economy is running hot and inflation is high.  Now to the dot plot, on which individual Fed governors predict where interest rates will be in the future.  As it is those very governors that vote on interest rate policy, I suppose, we should probably take note.  Way back in March, as the recovery was just taking hold, the dot plot indicated that near-zero interest rates would continue through at least the end of 2023. Yesterday’s dot plot told a completely different story, which includes multiple rate hikes in 2023.  Only 5 of the 18 governors expect rates to be near zero by the end of 2023, with the remaining bankers expecting hikes.  The median prediction suggests that Fed Funds will be at 0.625% by the close of 2023. That implies at least 2 rate hikes within that year, assuming 25 basis point increments. Additionally, 7 governors expect rate hikes in 2022 compared to just 4 in March.  There is no other way to interpret those predictions other than calling them hawkish. Of course, the Fed would most likely want the market to interpret it as “slightly less dovish”.  The Fed Chair attempted to add some color to the cold harsh facts of the dot plots and projections, telling reporters that “We’re a ways away from substantial further progress,” referring to the economic recovery.  Additionally, he acknowledged that the FOMC did not actually discuss the rate liftoff timeline.  Regarding the Fed’s bond purchases, he simply said that “You can view this meeting as the talking-about-talking-about tapering meeting.”  In other words, tapering is coming, though not likely to come soon, and the cutbacks would likely be slow and spread out over time.  Finally, Powell said that “Forecasters have a lot to be humble about,” implying that these are all just forecasts, and they should be taken lightly.  The Fed doesn’t like commitment and it gives itself lots of cushion by reserving what is referred to as optionality.  In other words, the Fed reserves the right to change and act as it sees fit based on the data that exists at that point… in the undefined future.  So saying and doing are two very different things.  Stocks sold off on the release, however indexes closed off of session lows, which was negative but not to an extreme.  Bonds sold off as well, with 10-year treasuries adding just +8 basis points.  The market will continue to interpret these latest developments in the days ahead.  Bear in mind that bond yields have already risen significantly off of their lows in the past year, and that Fed Funds futures predicted rate hikes in 2022 and 2023 already prior to yesterday’s release.  

THE MARKETS

Stocks sold off yesterday on a slightly more hawkish Federal Reserve, which now anticipates higher rates in 2023.  The S&P500 fell by -0.54%, the Dow Jones Industrial Average sold off by -0.77%, the Nasdaq Composite Index gave up -0.24%, and the Russell 2000 Index slipped by -0.23%.  Bonds fell and 10-year treasuries added +8 basis points to 1.57%… Cryptos slipped by -3.51% in yesterday’s session.

NXT UP

– Philadelphia Business Outlook (June) may have slipped to 31.0 from 31.5.

– Initial Jobless Claims (June 12) is expected to come in at 360k, down slightly from last week’s 376k claims.

– The Conference Board’s Leading Index (May) is expected to have advanced by +1.3%, compared to the prior month’s +1.6% increase.