The news yesterday from the Fed
Was Vice-Chair Clarida has fled
While later today
Chair Jay seeks to sway
The Senate to keep him Fed head
But in the meantime, it would seem
The narrative has a new theme
It seems pretty clear
Four rate hikes this year
Have gone from the fringe to mainstream
As we walk in this morning, there seems to be a lot of movement with respect to market expectations regarding the Fed’s actions going forward and exactly how those actions are going to impact the various markets. Today’s headline event is Chairman Powell’s renomination testimony in the Senate as everyone is waiting to see just how much effort Senator Elizabeth Warren puts into trying to derail the process. It is widely known that the Senator does not care for Mr Powell going so far as to calling him “dangerous” in his recent semi-annual testimony to the Senate. Yesterday, she also wrote a letter demanding to see all the personal trading records of all Fed officers which probably was part of the impetus for vice-Chair, Richard Clarida, to step down early from his post. So, on the one hand, we will be treated(?) to the scene of some Senators trying to play gotcha with the Fed Chair today with the ever-present possibility that some comment is made with a real market impact.
On the other hand, the tightening train has not merely pulled away from the station but is starting to gather serious speed. Earlier this morning, Atlanta Fed President Bostic commented that he sees 3 rate hikes this year and that the Fed “will act to ensure inflation doesn’t run away from us.” Futures markets are now pricing in a more than 60% probability of a fourth rate hike in 2022 with an increasing number of Fed speakers explaining a rate hike in March would be appropriate. We are also hearing the 4-hike scenario from an increasing number of pundits with Goldman Sachs economists publishing that view yesterday while JPMorgan Chairman Jamie Dimon explained that “four rate hikes of 0.25% each would not have an enormous effect on the economy.” And that is likely correct, a Fed Funds rate of 1.0% doesn’t seem that onerous for businesses. Of course, what impact would four interest rate hikes have on financial asset prices, especially if they were joined with a reduction in the size of the Fed’s balance sheet? And it is this latter question that seems likely to be the key as we continue to hear from more and more Fed speakers that the idea of allowing the balance sheet to ‘run-off’ is appropriate.
For those of you with shorter memories, the last time the Fed tried to reduce the size of its balance sheet, from 2017-2018, they were also raising interest rates, albeit far more slowly. Of course, CPI had peaked below 3.0% in that cycle, GDP was running at 2.4% and wages were growing at 2.5% while the balance sheet was less than half its current size. The point is conditions were clearly very different. However, not only did the equity market’s 20% decline inspire the Powell Pivot on Boxing Day 2018, but nine months later, the repo market blew up forcing the Fed to take dramatic action to ensure that sufficient liquidity was made available to the banking system. I assure you, neither of those outcomes were part of the carefully described plans the Fed had made to ‘normalize’ monetary policy.
Will this time be different? While starting conditions certainly are different, the one thing of which we can be sure is that the complexities of the international money markets remain opaque even to the central banks charged with their oversight. While there is no way to anticipate exactly what will happen to derail the current plans, one can almost be certain that things will not work out the way they are currently planned. Personally, I remain convinced that markets will have a very difficult time handling any reductions in the excess liquidity that has been the dominant feature of the post Covid-19 global financial markets, and that despite a lot of tough talk now, the Fed, at least, will be walking back that hawkishness before too long.
And perhaps, markets are beginning to agree with me. After all, hawkish monetary policy is rarely the backdrop for a risk-on attitude. Yet that is a pretty fair description of today’s price action. Equities are rebounding along with commodities; bonds are benign, and the dollar is softening.
While yesterday saw US equity markets in the red most of the day, the NASDAQ staged a furious late day rally to close flat although market breadth was awful (1205 gainers vs. 2201 losers). And while Asia was still under pressure (Nikkei -0.9%, Hang Seng 0.05, Shanghai -0.7%), Europe has taken heart from something as we are seeing solid gains across the board there (DAX +1.15%, CAC +1.35%, FTSE 100 +0.7%) despite a complete lack of news. US futures, too, have turned green with all three main indices up about 0.3% at this hour.
The Treasury rout is on hold with yields essentially unchanged this morning and the 10-year right at the key level of 1.75%. In Europe, Bunds (-0.9bps) and Gilts (-2.3bps) are both trading well while the rest of the sovereign market is virtually unchanged. Again, there has been essentially no news of note.
Oil prices are rallying (WTI +1.4%) while NatGas (-0.9%) has consolidated some of yesterday’s gains despite the fact it is 14 degrees here in NJ this morning. Gold (+0.3%) and silver (+0.6%) are both firmer, as are industrial metals (Cu +0.6%, Al +0.1%, Zn +2.4%) and the ags are strong as well.
Finally, the dollar is under modest pressure with NOK (+0.4%) leading the G10 revival on the strength of oil’s rally, while CAD (+0.3%) follows closely behind. JPY (-0.25%) is the only laggard here, again pointing to the risk characteristics in today’s price action. EMG markets have seen similar price action with THB (+0.6%) the leading gainer followed by HUF (+0.4%) and KRW (+0.35%), all benefitting from the pause in the US yield rally and generally better risk appetite.
Today’s only data point has been released, NFIB Small Business Optimism (98.9, slightly better than 98.7 expected) and has had virtually no impact on the market. This brings us back to the Fed as today’s most likely catalyst, as not only will we hear from Chair Powell starting at 10:00, but also from two of the most hawkish regional bank presidents, Mester and George between 9:00 and 9:30.
With risk in vogue for the session, I expect the dollar will have difficulty gaining any ground, but nothing has changed my short-term view that the Fed’s hawkishness is going to be the key driver of a stronger dollar…right up until they reverse course!
Good luck and stay safe