2022 has seen its share of harrowing sessions on Wall Street. But Thursday was bad even by this year’s “high” standards.
US equities plunged nearly 4%, erasing the entirety of Wednesday’s post-FOMC rally — and then some. At one point, the Nasdaq was down nearly 6%.
Thursday ranked among the worst days since March of 2020 (simple figure below).
To their credit, mainstream financial media outlets seemed to be in on the joke — there were oblique references to the sheer absurdity of the reversal and even veiled jokes about their own penchant for rationalizing the inexplicable.
Ironically in that context, Thursday’s session actually was amenable to analysis. Losses for equities snowballed during a rapidly escalating bond selloff which eventually eased — Treasurys were off their worst levels by late afternoon. I offered a hodgepodge of explanations for the weakness in bonds, including a disconcerting read on unit labor costs (which fanned wage-price spiral fears) and the notion that the market is trying to say something about the low odds of slaying the inflation dragon without drastic measures of the sort Powell explicitly ruled out during Wednesday’s press conference.
Those two explanations aren’t mutually exclusive. In fact, they’re related. If the market was already concerned that the Fed won’t do enough, the productivity data may have exacerbated those fears. The BoE’s projection for double-digit inflation in the UK didn’t help matters. If inflation isn’t going away soon, the Fed needs to do more than thread needles at press conferences after well-telegraphed 50bps hikes. That was one interpretation of yields’ push to new cycle highs.
That said, there was a bit of nuance worth parsing. It was notable that the selloff in bonds was attributable to reals, not breakevens (figure below). So, while you could read the bear steepener as a warning to the Fed, the reals-driven move complicated interpretation.
“Bear steepening has admittedly been a somewhat elusive phenomenon over the last several months, and while the Bank of England decision was initially credited with the impulse, we’ll admit a degree of marvel at the extent to which the move extended,” BMO’s Ben Jeffery and Ian Lyngen said, on Thursday afternoon. “The decided break of 3% 10s belied the underlying response in the TIPS market and 10-year real rates that moved above 20bps and back to within striking distance of… the peak achieved in late 2019 before the pandemic,” they added.
On one hand, that’s desirable for central banks. They need to tighten financial conditions and ensure the outlook for prices down the road remains anchored. So, higher real yields and steady (or falling) market-based measures of inflation expectations is a good outcome.
But it’s a delicate balancing act. I argued Thursday afternoon that under the circumstances, the Fed may have welcomed the equity selloff to the extent it erased Wednesday’s rally, which worked at cross purposes with the Committee’s desire to tighten financial conditions. That said, there’s a point beyond which deteriorating risk sentiment becomes a self-fulfilling prophecy. Once activated, that psychological feedback loop can be difficult to short circuit. Powell knows that all too well from the December 2018 experience.
“10-year real rates came into this week at -3bps and a 25bps selloff over the course of just four days is clearly coming at the expense of risk asset valuations,” BMO’s Jeffery and Lyngen went on to say, adding that “while the Fed is likely encouraged by inflation expectations continuing their post-meeting pullback, the S&P 500 down nearly 3.5% and VIX back above 30 highlights the flipside of a tightening policy backdrop.”
Takes SP500 and NDX back to Monday, so the glass-half-full way to look at is that the indicies have done more-or-less nothing this week so far. I prefer the glass-half-empty interpretation myself.