Fever Pitch

Wall Street marked an inauspicious start to a holiday-shortened week.

Treasurys were heavy throughout the session, weighing on US equities and dealing another blow to investor psychology at a delicate juncture. Fed speculation is running at a fever pitch.

Deutsche Bank’s Matt Luzzetti called it “less likely, though still possible” that Jerome Powell could preside over a 50bps hike. “Such a scenario would likely require clear evidence of an unanchoring in the inflation process, with no improvement in inflation data, long-run inflation expectations moving sharply higher and an increasingly tight labor market,” he said.

The bank doesn’t think an outsized move is in the offing for March, but Luzzetti did say the “risks of a much more aggressive tightening cycle… have clearly risen” with the implication for traders being that “the range of monetary policy outcomes has widened drastically.”

That’s not the best news for equities. This isn’t a Fed that’s tightening “because growth.” It’s a Fed that’s panicking “because inflation.” It’s also a Fed that’s currently running the risk of being forced, by markets, into adopting a more aggressive stance than they otherwise might. Officials had a chance to walk it back last week, but they didn’t. That makes this week’s pre-FOMC blackout silence deafening. March is fully priced (25bps, for now).

A late block sale in five-year futures left yields near the cheapest levels of the session. The 5s30s was the narrowest of the cycle. But there was little in the way of evidence that the long-end was inclined to “listen” to equity weakness or even politely acknowledge the possibility that the Fed may end up serving as a drag on the economy. 10-year yields ended near 1.87%.

This is all positively oppressive for tech. The Nasdaq 100 is on track for its worst month since March of 2020 (simple figure below).

Cathie Wood’s flagship fund dropped another 3% Tuesday, extending 2022’s early losses to 18%. And no, that’s not a typo.

The rise in real yields will continue to pressure stocks, especially those with elevated multiples. 10-year reals reached -64.5bps Tuesday, the “highest” (scare quotes to acknowledge we’re still deeply negative) since April.

The rapidity of this year’s surge in real rates (figure below), predicated as it is on expectations for Fed tightening, will prompt forced de-rating in expensive corners of the equity market. Earnings season may mitigate the situation to the extent profits come in ahead of expectations. Fingers crossed.

Tuesday was “a pretty standard ‘financial conditions tightening tantrum,'” Nomura’s Charlie McElligott said. “The move in Reals [is] particularly painful to the ‘Secular Growth’ Nasdaq, as ‘rich’ valuation / high-multiple stocks continue to re-rate lower.”

The read-through for the economy is still unclear. The data is starting to roll over, with Tuesday’s huge Empire manufacturing miss just the latest in a string of disappointments.

BMO’s Ian Lyngen and Ben Jeffery flagged this month’s 20bps drop in breakevens, which sticks out considering surging oil prices. “It’s a strong vote of confidence in the Fed’s implied credibility that not only will the Committee follow-through on the hawkishness but that it will also be effective in containing consumer prices,” they wrote, before dryly noting that “the former is more obvious than the latter; after all, with oil at its highest level since October 2014 and the Fed’s acknowledgment that supply chain issues have been instrumental in driving inflation higher, we’re left to ponder how useful higher rates will be in resolving these particular issues.”

And that really gets to the heart of things. It’s possible the Fed ends up orchestrating a (hopefully controlled) demolition of the post-pandemic economic boom (and attendant equity bubble) but without doing much at all to bring down inflation.

Howard Marks summed up the outlook for markets during an interview with Bloomberg TV. “I’m worried about inflation. Inflation is excessive,” he said. “Higher inflation means higher interest rates. And higher interest means lower asset prices.”

But don’t worry. You can ride out this storm. As Erik Schatzker wrote, summarizing, Marks reckoned investors concerned about rising prices can find shelter in “assets such as floating-rate debt and property.”

So, if you’re an average household worried about the surging cost of energy, rising grocery bills and a 401(k) that’s stuffed with duration-sensitive equities through no fault of your own, just pile into leveraged loans and buy some land. How hard is that?

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7 thoughts on “Fever Pitch

  1. “It’s possible the Fed ends up orchestrating a (hopefully controlled) demolition of the post-pandemic economic boom (and attendant equity bubble) but without doing much at all to bring down inflation.”

    Well put, sir.

    Sadly, that may not be the worst possible outcome. But I’m a perennial worrywart.

  2. I don’t know why, but I’ve been surprised by the speed of the rise in Treasury yields. And even though I’ve been long cash for a while, I was hoping to sit tight with the actively managed portion of my portfolio and ride out the recent volatility. The pain got to be too much today, though — as a recently retired person, capital preservation is a priority — and I headed for the hills. We should get a snapback in some equities from oversold conditions, but I think it’s going be rocky couple of months, with the trend in both stocks and bonds to the downside. Good luck to all.

    1. congrats on your retirement…that was me in March 2020 and I too dialed back a lot of investments for the peace of mind…it works out fine as long as you stay true to your financial and life priorities…and stay current with H of course…congratulations…

  3. H-Man, dripping with sarcasm to explain the solution which I love. The 2 barrier is being assaulted and I will go with McE that when 127 breaks, hang on. Futures tonight indicate 7 ticks away from 127 which is a drop in the bucket. The move is relentless. Toss in a Russian invasion of UKR and oohlah we have 2%.

  4. The only way we get out of this alive is if higher rates are paired with continued fiscal stimulus — allow households to deleverage while supporting demand (ideally in the form of capacity-increasing initiatives, like universal childcare). Instead, all we’re going to get is austerity from the current admin, either by politics (Manchin/Sinema) or by preference.

    So what does that leave us with? Cratering demand as the last of the fiscal stimulus moves through the economy and borrowing costs hit their highest in 15 years. This is by design, of course. No surprise that Powell turned back into a hawk the moment he was re-nominated. The alternative was a world in which targeted fiscal stimulus became the norm, where Americans could simply expect their government to support consumer demand with checks in the mail. Was there ever really a chance of that happening, though? I know I was deluded into thinking so, for a while.

  5. Yeah go ahead and buy up some property that will be devalued within a year, that’s a great investment! Lower loan liquidity and higher rates do NOT equate to real estate being a sound investment.

    So here we are, the Fed is responsible for solving a pandemic driven crises and with trying to regulate the QE addiction. One they are ultimately responsible for, the other they have no real power to impact.

    Everyone was fine with inflation as long as it was used cars, stocks, crypto, and real estate that was inflating. Now that consumer prices are inflating everyone is flipping out. The irony is that no one is able to recognize that asset inflation also contributes to consumer price inflation.

    If the government wants to stop the hemorrhaging on the crappy jobs front I would suggest that they adjust minimum wage to a living wage, this really should be done at a state and locality level since living wages vary by those distinctions. States obviously aren’t going to do this and they are always so late to the game that by the time they actually do raise wages it’s to keep those workers in the middle of the poverty index. Money is a great incentive, it should be used to solve this problem.

    1. @cdameworth, I think the appeal of real property is the income stream which may match or outpace inflation.

      Of course, rising lending rates make the current spread to cap rate thinner, but with many rent categories currently inflating at high-single or double-digit rates, income property generally looks attractive (caveat: location, location, location).

      The speculators holding vacant property for pure price gains will, hopefully. have a tougher time of it.

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