If Stocks Don’t Get Him, The Curve Might

If Stocks Don’t Get Him, The Curve Might

Thursday's overarching narrative was that this time around, Jerome Powell isn't going to bend the proverbial knee to equities. The emphasis on "this time" is, of course, a nod to Powell's dovish pivot on January 4, 2019, when, while seated next to Janet Yellen and Ben Bernanke, our shell-shocked protagonist took the first steps down the road to abandoning the rigid policy stance that contributed to the worst December for US equities since the Great Depression. Were it not for the pandemic, tha
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9 thoughts on “If Stocks Don’t Get Him, The Curve Might

  1. I think we’ll see another 50bps rise in reals and 10% drop in the S&P before the first rate cut in March. After two quarter-point increases (March and April), I think the Fed will pause a month or two to reassess. Maybe it’ll pause on rate hikes and opt instead for a modest amount of QT. (No reason they need to do both at the same time.) I think a 20% drop in the S&P, two quarter-point hikes, and steady improvement in the supply chain situation should be enough to cap inflation expectations. But if inflation is still running at 7% and/or rising in March-April, all bets are off.

  2. H is correct about equity market not being the binding constraint for the Fed that it was. But the yield curve is- and even more important are credit conditions. If you see credit spreads widen significantly, I don’t really care what the stock market or yield curve does, the Fed will at least pause. My own guess is the curve flattening more will proceed a credit widening – if stocks somehow manage to escape the initial curve flattening a credit widening event will likely doom the stock market. Powell and the FOMC are talking dirty now- and the market is obliging by tightening financial conditions before the Fed even fires a shot. It really looks like the Fed will not want to or be able to tighten 5-6 times this year. Our economy is so leveraged that it won’t take that type of rapid tightening in a short time frame. You are already seeing an inventory build. That is the first step to supply chain normalizing. If you start to see nominal growth go down significantly the Fed won’t be tightening anything near the talk. For many moons I have been saying the Fed ought to target nominal growth as one of its metrics. Why? There is no argument over which is the right inflation number and the gross number is easier and more useful a figure anyway. Figure 6% is a good number- at that level growth should be ok, and inflation should be tolerable as well. When the nominal rates sinks much below 4.5% you are looking at stall speed for the economy.

  3. I am concerned about yield curve as well. 2Y-10Y of only 60 bp is full of pre-recession cues. Zoltan (CSFB) opined the Fed should actively sell Treasuries rather than passively let them run off, in order to target specific parts of the yield curve. The Fed’s $5.4TR of Treasuries is 20% 0-1Y, 38% 1-5Y, 18% 5-10Y, 24% 10+Y. So a passive run-off approach to its Treasuries would mean shedding only short maturities for some time. Seems that would push the short end up more than, or sooner than, the long end. Add economic slowdown fears and we could have a flat curve by mid-year. Since the market front-runs everything, make that “in a couple months”. Even if the Fed doesn’t care – and surely they do? – the banks and all manner of non-bank financial players sure will. Some big and hitherto unknown (at least to me) carry player blowing up could cause the widening credit spreads described by @RIA.

  4. H-Man, Powell just can’t say no to a question during a fed presser which is the reason he sends markets sky rocketing or diving. Mostly diving. Yes the inverted curve has preceded recessions but generally it takes time before the big R lands. The curve inverted in May of 2019 and then again in April of 2020 when Covid hit. But when the curve inverted then, the recession that started in February was over by April. The curve inverted in 2005 but the Great R didn’t show up until 2007. So if it inverts, not sure a R lands immediately. It would seem this market still has legs since Omicron appears to be in the rear view mirror.

    1. The problem is that this cycle is going a lot more rapidly than in recent years including the great moderation prior to the GFC and post GFC. That is partly by design- the governent stepped in with a bazooka gun of fiscal and monetary stimulus. Part of that stimulus, pulled forward demand for durables, especially housing and autos which were further supercharged by demand from a market basket shift by consumers. When car production picks up, and more housing gets built do you think there will be that much excess demand for those things. The only fact that might bail these sectors out after 2023 is demographics- the millenials are now in the ideal age range for those things. And it is a big demographic cohort. The rise in inventories is a hint of more of this to come.

      1. A typical late cycle performer is oil and gas. And perform it is, but a look at cycles would suggest that we are closer to the end of this one than the beginning.

        1. Oil and gas seem like THE under appreciated story at the moment. The market is perilously tight. The read through of any worsening imbalances could be quite severe for inflation, politicians careers, and most people’s budgets.

        2. IIRC other typical late cycle performers are in industrials sector, and that is working too. Another hiding place has sometimes been so-called “secular growth” names, but . . .

          I agree this cycle is looking super-speeded. I don’t have much conviction on whether we actually get a recession, or whether it is a “real economy recession” or a “technical recession” or a “growth recession” or whatever – I’m even confusing myself. But the late-cycle playbook needs to be dusted off. Will be hard because the last time I looked at it, a big part of it was “buy IG”.

      2. @Rolling-In-Assets: How “rapidly”? So “rapidly” they won’t even have time to resurrect FLAT (iPath U.S Treasury Flattener ETN) and STPP (iPath U.S. Treasury Steepener ETN) perchance?!?

        Rooting around, a habit wee worms share with bears, for fun facts not already covered about bear-flattening conditions, looking especially for graphics of such times in the wayback, I probably failed in the “fun” quest, but, at least I stumbled upon old interesting @H tracks deep down in his seekingalpha article stack. So many great headlines, alas, so little time.

        The key point @hookandgo might bear in mind, is that S&P500 returns are not likely to be stellar in 2022, with or without a “big R”, but, also bear in mind, degraded SPY performance will precede in real-time (now-time) any big R (which is only determined to be a Recession in hindsight, so not really all that interesting/useful to us in the present). A typical quote suggestive of the prevailing wisdom surrounding bear-flatteners then and now, is in this example from The Purchasing: The magazine for chief procurement officers and Supply Chain executives, February 3, 2005 Volume 134 Number 2 (“The Metals Edition!”), by none other than “Robert Doll, president and CIO at Merrill Lynch Investment Managers in New York”, presented as predictions for the year ahead:

        “4. Interest rates continue to move higher as the “bear flattener” takes the Fed’s rate to 3.5% and drives 10-year Treasury yields to 5%.
        5. U.S. stocks struggle, but outperform bonds and cash for the third year in a row.”

        Doll suggests poor stock performance is anticipated relative to prior years, but, not necessarily in absolute terms.

        The rub though is we are always in danger of getting to comfortable and confident with received ‘wisdom.’ It’s like a default setting our brains have. Every time I get my mind blown and have to push in the microscopic little red reset button I’m right back to “conventional reception” default. Yet another straightened paper-clip ruined! The path of least glucose burn I suppose. Conventional wisdom current sample,

        “The quick rise in Treasury yields, especially on the short end of the curve, has pushed us into a Bear Flattener regime. During those periods, the S&P 500 has showed the weakest growth. Other assets haven’t done much better. Real Estate, Financials, and Value stocks have typically performed the best.”

        How then to vigilantly mind the bear traps? How to avoid self-disarming in the presence of the comfortably conventional? How to remember to at least reconsider base rates? What system do we have in place to routinely revisit investment assumptions and re-test them? Not that “conventional” is all wrong all the time. It is often a ready made starting point and that can cut down on initial flailing around time while looking for some purchase on new/old problems. Guess that’s where the @H value-add comes in if we’re lucky enough to read/understand the right post(s).

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