Recession is on the table

Stocks fell modestly yesterday after traders carefully parsed Chairman Powell’s testimony. According to the Fed Head, avoiding a recession is going to be a challenge.

The man in the corner office. If you are going to ask somebody about interest rates, the stock market, or the economy, you really should ask the Chair of the US Federal Reserve. It is, after all, the Fed that is closer than any other public or private entity to the engine of the economy. To be clear, the Fed doesn’t control the economy, but its action AND WORDS can have a significant impact on it. Now, it is probably going to be difficult to get a slot on Powell’s calendar, as he and his team are busy fighting, what some have called, the worst inflation in a generation. Sidenote on that: I wish I were that young. So, if Powell is too busy to sit down for a chat, the next best thing would be to listen to him speak in a public setting.  

Jerome Powell himself, was the first Fed Chair to institute a press conference after every FOMC meeting while, historically, those only occurred after every other one. The Chair instituted the change because he recognized the impact that “guidance” could have on the markets and the economy. If the Fed hints that rates are going higher, the markets instantly react and reflect the changes. A clear, recent example of this occurred with 30-year fixed mortgage rates. Mortgage rates had gone from around 3.25% at the beginning of the year to around 4.25% before the Fed even made its first hike (+25 basis points) in mid-March. Once it became clear that the Fed was going to continue to raise Fed Funds, mortgage rates continued to climb in anticipation. Since that initial rate hike in March, the Fed has tacked on another +125 basis points, during which mortgage rates continued to climb disproportionately. At current, the Fed Funds Rate is around 1.5%, up from 0% while mortgage rates are around 6%, up from around 3%. It is not just markets that react to the Fed’s commentary, but consumers as well. When consumers read about rate hikes in the news, they change their purchase habits. Even more impactful, when consumers hear the Fed mention a recession, they are quite likely to pull back on the spending in anticipation of rough times ahead. So, it is clear that words have meaning when they come from the central bankers, and that is precisely why the Fed Chair carefully selects his words when he speaks. In the post-FOMC press conferences, even though reporters can ask questions, Powell sticks to a carefully scripted agenda. In his last presser the Chair hinted at the possibility of a +50 or +75 basis-point hike. The market had fully factored in a +75 basis-point hike, so the hint of a +50 basis-point hike was viewed as being positive by the markets.

Twice a year, the Federal Reserve chair testifies in front of Congress in what is known as Humphrey Hawkins Testimony. In that testimony, the Chair goes over monetary policy with senators and house members. The chair prepares a speech, which sounds a lot like the speech he gives at his FOMC press conferences and then the lawmakers have an opportunity to ask questions. As you might guess, those testimonies are rife with political grandstanding as lawmakers apply immense pressure on the Chair. In that environment, even the most buttoned up bankers can be moved to drop some hints on the path of rate hikes. Yesterday, Powell was testifying before the Senate Banking Committee and he dropped a few interesting hints, some old and some new. He was clear on the Fed’s keenness on fighting inflation, though his wording was softer than in prior discussions. He further went on to make it clear that, though rates needed to be higher, the path and magnitude of those hikes would very much be data dependent. That implies that if the economy slows down, the Fed may stop hiking, or even cut rates (depending on your level of optimism). Of course, that also means that the Fed could hike more aggressively if inflation intensifies (depending on your level of pessimism). Powell relayed to the lawmakers that he believed that the economy was strong and that it could take the rate hikes. However, he did warn that engineering a soft landing was going to be “challenging”. Wait, did the Fed Chair hint that there was possibility for a recession?! Well, he didn’t just hint it, he said it. When questioned on the matter, Powell said that there was possibility that Fed rate hikes could cause a recession. Ok, so what does that mean for us?

Markets immediately reacted. Bond yields came down as traders began to factor in slower growth, lower inflation, and LOWER INTEREST RATES in the future. Lower interest rates and the possibility of a policy shift can be bullish for stocks. Stocks rallied initially, but the news was not good enough to keep indexes in the green and they turned slightly lower into the close. Now, we can expect some shifting around in the days ahead as traders begin to ponder the possibility of a recession and prospect of peak hawkishness by the Fed. The saga continues today as the Chair will give his second day of testimony on the Hill…pay attention, it is words, not actions, that are important for the market right now.

YESTERDAY’S MARKETS

Stocks slipped yesterday after spending most of the day in positive territory as traders pondered the Fed Chair’s testimony to the Senate Banking Committee. The S&P500 fell by -0.13%, the Dow Jones Industrial Average traded lower by -0.15%, the Nasdaq Composite Index was off by -0.15%, and the Russell 2000 Index declined by -0.22%. Bonds gained and 10-year Treasury Note Yields fell by -12 basis points to 3.15%. Cryptos declined by -4.02% and Bitcoin gave up -4.71%.

NXT UP

• Initial Jobless Claims (June 18) is expected to come in at 226k, slightly lower than last week’s 229k claims.
• S&P Global Composite Flash PMI (June) may have fallen to 52.9 from 53.6.
• Kansas City Fed Manufacturing Activity (June) is expected to have fallen to 13 from 23.
• Fed Chaiman Jerome Powell will testify in front of the House Financial Services Committee.
• This morning Rite Aid beat EPS and Revenue estimates and we will get results from FedEx after the closing bell. That’s right, earnings season is just a few short weeks away. Expect to get more individual stock information from me as the season ramps up.