No Delay

There once was a banker named Jay
Who had a quite trying first day
A week has now passed
And he’s been steadfast
That rate hikes will see no delay

Investors, however, are sore
‘Cause most of the ten years before
Each time stocks would sink
The Fed Chair would blink
And open the taps even more

So what can we look for ahead?
Is this market bull really dead?
It’s still early days
But I think this phase
Has room to become more widespread

This morning’s market activity is far more subdued than what we saw last week, which is not that surprising. As I have written many times, periods of extreme volatility tend to be short-lived simply because traders don’t have the stamina to maintain the pace of activity. This is especially so these days since most traders have barely even seen this type of market movement and are uncertain how to respond. When all your trading models are predicated on markets rising forever, falling markets can be quite confusing.

Friday’s late day equity rally was quite interesting in both its timing and power. It appears that a research note from JPMorgan was released which essentially sounded the all-clear signal. The essence of the note was that they estimated the bulk of the risk-off selling had been completed, so no need to panic further. It is not often when somebody rings the proverbial bell and tells you the market has either topped or bottomed, but apparently, that is what we just saw. Personally, I remain skeptical that the volatility has ended and I make that case because a quick peek at the 10-year Treasury this morning, currently making new highs at 2.88%, highlights that the initial driver, rising yields in the US, are continuing on their merry way. Once again I will point out that we have had nine years of QE and extraordinary monetary policy and a nine-year equity and bond market rally (actually the bond market rally has been about thirty years). As monetary policy tightens, and there is no indication at this point that the Fed is changing their tune, those two rallies are certain to suffer. A one-week correction is not sufficient to offset a nine-year rally. I’m sorry, but there is more downside to come.

Turning our gaze to the FX market, the dollar is under very mild pressure this morning. While it is weaker against a majority of its major counterpart currencies, the magnitude of the decline is tiny, probably about 0.1% on average. In other words, I wouldn’t put much stock into stories describing the dollar’s decline as being significant. I find it interesting that the FX narrative revolves around tighter policy elsewhere in the world, hence the idea that the dollar has further to fall, but the equity narrative is that rising rates will have no impact on stock prices. This seems to be a conundrum given the historic relationship between interest rates and equity markets. In fact, the anomaly has been the fact that during a powerful equity market rally we saw declining yields, which is historically very rare. Normalization of monetary policy is very likely, in my view, to reinvigorate historical relationships. It is why I believe that Treasury yields will continue to rise; why I believe that the equity market will come under further pressure; and why I believe the dollar will find support. Until the Fed changes their current storyline of continuing to gradually raise rates and allow the balance sheet to shrink, we are going to be subject to ongoing downside activity and increased volatility. [A quick aside on this. The Fed is NOT selling any bonds in the market, although that has been widely reported. The change they have made has been that rather than take the proceeds of the bonds that are maturing in their portfolio and reinvesting them, thus buying more bonds; they are simply letting a portion of these maturities roll off without being replaced. These funds then disappear from the market in exactly the opposite manner as when the Fed ‘printed money’ from thin air and bought bonds. I assure you that if the Fed were actually selling bonds in the market, Treasury prices would already be much lower and so would stock prices!]

This week has a much more active data calendar but I think that all eyes will be on Wednesday’s CPI reading which, given the importance of the inflation debate, has the ability to be a market mover. Remember what happened with the AHE number two weeks ago. Here’s a listing of what is upcoming:

Today Monthly Budget Statement -$23.0B
Tuesday NFIB Small Biz Optimism 106.2
Wednesday CPI 0.3% (1.9% Y/Y)
  -ex food & energy 0.2% (1.7% Y/Y)
  Retail Sales 0.2%
  -ex Autos 0.4%
  Business Inventories 0.3%
Thursday Initial Claims 229K
  Empire Mfg 17.3
  Philly Fed 21.1
  PPI 0.4% (2.5% Y/Y)
  -ex food & energy 0.2% (2.1% Y/Y)
  IP 0.2%
  Capacity Utilization 78.0%
Friday Housing Starts 1.23M
  Building Permits 1.3M
  Michigan Sentiment 95.5

On the speaker front, only Cleveland’s Loretta Mester is on the schedule, and she is a known hawk, so unless she turns dovish, it is unlikely to have a major impact on markets.

For today, if the equity market picks up where Friday closed, and futures are pointing nicely higher right now, about 1%, then I expect the dollar will potentially edge a bit lower. However, if we experience the next wave of derisking, look for the dollar to find support.

Good luck