Panic Button

However it turns out for US equities this week, I can confidently say, one full day ahead of Friday’s closing bell, that it should’ve been worse.

Early Thursday, following a truly disconcerting read on inflation, fed funds futures were starting to price in an inter-meeting rate hike. In other words, the odds of an emergency move before the March FOMC are growing in the eyes of the market.

That was before Jim Bullard told Bloomberg that he wants “100 basis points in the bag by July 1.” Although he was polite enough to defer to Jerome Powell on whether the Fed should start with 50bps, he’s for it. “I was already more hawkish but I have pulled up dramatically what I think the Committee should do,” he said.

Two-year yields, which were likewise “up dramatically” on the session, rose even further. A so-so auction around the time Bullard spoke didn’t help, but frankly, nobody cares about a one basis point tail at a 30-year sale at a time like this. Thursday’s 22bps move (figure below) won’t easily be forgotten, even if it is easily faded.

Needless to say, Bullard’s remarks were gas on the fire vis-à-vis inter-meeting hike speculation. Indeed, he seemed to suggest an emergency move is on the table. “There was a time when the Committee would have reacted to something like this,” he said of the CPI data, before exhibiting something like nostalgia for the old days, when a 7.5% headline inflation print would’ve meant the Fed “having a meeting right now and doing 25 basis points right now.”

“I think we should be nimble and considering that kind of thing,” Bullard added. Recall that “nimble” was one of Powell’s buzzwords from the January press conference, although I’m not sure this is quite what he meant. At one point, markets were pricing something like a one in three chance of a 25bps hike before March’s meeting.

After noting that Thursday’s jump in two-year yields was the largest in a dozen years, Bloomberg’s Cameron Crise wrote that “these types of moves were a regular feature of fixed-income trading before the GFC.” Fortunately, he didn’t leave it at that, because if he had, his chats would’ve lit up with traders stating the obvious. “Of course, that was from a much higher yield base, so in a real sense today’s move is bigger from a capital loss perspective than an equivalent one in, say, 1994,” he went on to write.

In all likelihood, today will be remembered as an overreaction, although it’s not clear on whose part. BMO’s Ian Lyngen and Ben Jeffery correctly observed that “the pressing issue is whether the 0.1 pp beat [on core CPI] warranted two-year yields above 1.50%.” The implication was that the move may be overdone. The only rationalization is “if one believes the second consecutive +0.6% monthly gain in core prices will be the tipping point for the Fed to up the liftoff ante from 25bps to 50bps,” they added.

Personally, I found the CPI report to be far worse than the headline prints suggested. The breakdown appeared to show price pressures are now embedding themselves across virtually the entire economy. Whether traders took the time to read the fine print and then made a rational decision to push the rate hike envelope (hard) is admittedly a stretch — people, and certainly algos, trade headlines, not details, and certainly not nuance. And, again, it’s not obvious that the headline beats were in themselves “that bad,” so to speak, relative to expectations.

But Bullard seemed very concerned. So, maybe it wasn’t the market overreacting to CPI. Maybe the market got slightly ahead of itself (as it’s wont to do) before lunchtime and then reacted rationally by extending the move based on the perception that Bullard was panicking. And that perhaps his concerns are representative of the Fed’s thinking following the inflation numbers, which officials presumably parsed more closely than market participants.

Who knows. What I do know, though, is that stocks should’ve reacted more violently to the combination of a 20bps rise in two-year yields, a prominent voter using what counts as alarmist language while discussing inflation with Bloomberg and 30% implied odds of an emergency, inter-meeting rate hike.

Equities were down sharply as the closing bell neared on Wall Street. But not sharply enough.