Can interest rates be rising sooner than expected

As expected.  Stocks rose yesterday after the Fed signaled its taper plans, mostly expected. Evergrande announced that it had sorted out its interest payment, due today, providing relief to the markets’ earlier in the week anxiety.

N O T E W O R T H Y

Done and dusted.  Knowing is everything when it comes to the markets, and yesterday is proof. There are many unknowns swirling around in the markets these days, principal amongst them is Fed policy.  The Fed has been like a benevolent parent for quite some time.  In fact its support dates back to Christmas of 2018, far before the onset of the pandemic.  Can you even remember that far back when the market was tumbling and Fed Chair Powell made his first dovish shift, which helped pull the stock market out of a vicious funk, sparking off a rally that would enable the S&P500 to gain +28.88% in 2019?  That gain was helped along by a series of 3 rate cuts in the second half of that year.  With 2020 and the onset of the pandemic, the Fed slammed rates down to effectively 0%, and initiated a collection of monetary stimulus tools the likes and proportions of which had never been witnessed.  Talk about benevolence.  That boost along with extraordinary fiscal measures helped turn the economy around, spurring the stock market to rally by +16.26% (S&P500) for 2020. More stimulus in this current year provided the safety net for a year to date gain of +17.03% for the S&P.  We all know that this current level of support simply can’t last forever.  The big question leading up to yesterday’s FOMC announcement was “when will that supportive parent send the markets off on their own after 33 months of succor?”  That question was answered yesterday… mostly.

The Fed made it clear in its policy statement that tapering may be appropriate, “soon.”  The Fed Chairman added clarity by stating that the Committee had discussed the start date and pace of tapering its $150 billion monthly bond purchases.  Though no decision on those was made, he further, strongly suggested that the majority of members expected to wrap up tapering by mid 2021.  That has been interpreted by many as the likelihood that the Fed will announce its taper plans after its November 3rd meeting and begin to taper slowly through the summer of 2022.  Some have reckoned that the Fed will taper by $15 billion per month for 10 months.  Considering the size of the treasury market, that doesn’t appear too ominous and is likely the reason why treasury yields were relatively docile yesterday. So, one might say, the markets expected it.  While the Fed’s steady monthly bond purchases have been a factor in keeping yields lower, it was hardly able to stave off the sharp rise in longer maturity treasury yields that ensued late last year through March of this year.  Why all the fuss, then?  Though the Fed has signaled that rate hikes are “a ways away” (its words not mine), it has also signaled that the ending of bond purchases would predate rate liftoff.  Yesterday’s taper pace suggestion appears to hint that the Fed is seeking rate hike optionality in the second half of 2022.  That is backed up by the dot plot which showed that 2 more FOMC members defected into the hawk zone for 2022 bringing the kettle of hawks to 9… out of 18 members.  This suggests the likelihood of one rate hike by December of next year.  The markets appear to back up this scenario, as well.  Fed Funds futures suggest that at least one 25 basis point hike will occur in the Fed’s December 14, 2022 meeting.  Delving a bit further into yesterday’s release, we see that Fed members cut back on the current year’s GDP growth forecast but bumped up growth for 2022 and 2023.  The Committee further scaled up its inflation projection for the current year and next, with next year’s median PCE inflation projection coming in at a tame +2.2%, suggesting that the Fed still believes in its transitory thesis.  

At the end of the day, investors were not shocked by any of the releases, though they may have been slightly surprised by increased probability of a rate hike late next year.  I carefully selected the adverb “slightly,” because stocks did not sell off on the news, and more importantly, bond traders appeared to be completely unvexed.  Finally, it is important to note that these are all projections and that the Fed has the ability to do anything at any moment “as is necessary” to sustain its duel mandate.  The Fed, for now, has accomplished an important goal: signal to the markets that its benevolence is on its way out without causing a panicked selloff in stocks and bonds.  Markets typically take a few days to digest a signal of this magnitude, but for now the news came in as expected, and knowing is everything.  

THE MARKETS

Stocks rallied yesterday, closing off of its session highs, on better news from Evergrande and no surprises from the Fed.  The S&P500 climbed by +0.95%, the Dow Jones Industrial Average rose by +1.00%, the Nasdaq Composite Index added +1.02%, and the Russell 2000 Index advanced by +1.48%.  Bonds climbed and 10-year treasury yields gave up -2 basis points to 1.30%.  Cryptos climbed by +3.65% and Bitcoin added +6.17% after a 3-day selloff.

NXT UP

– Initial Jobless Claims (September 18) are expected to come in at 320k, down from last week’s 332k.

– Markit Flash Manufacturing PMI (September) may have eased to 61.0 from 61.1 and the Services component may have pulled back to 54.9 from 55.1.

– The Leading Economic Index (August) is expected to have risen by +0.7% after climbing by +0.9% in July.

– This morning Darden Restaurant beat on EPS and sales.  After the bell, we expect to hear from Costco, NIKE, and Vail Resorts.

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