Markets Brace For Impact As Fed Whisperer Tips 75

Headed into the new week, I suggested on multiple occasions that the market was on the brink of losing all faith in the Fed and that both equities and bonds would continue to bleed absent a compelling reason to believe policymakers are poised to get a handle on the inflation problem.

Those warnings were, unfortunately, borne out on Monday. Stocks and bonds were both beset, but the real drama came in the final hour, when the S&P extended losses and yields rocketed higher by as much as 36bps at the front-end.

The proximate cause of the late-day fireworks was a Nick Timiraos article. “A string of troubling inflation reports in recent days is likely to lead Federal Reserve officials to consider surprising markets with a larger-than-expected 75bps interest rate increase at their meeting this week,” he wrote, in a piece published after 3 PM in New York. Timiraos is, of course, the Journal‘s “Fed whisperer.”

Two-year yields went parabolic. The wild move up to ~3.40% came atop Friday’s 25bps jump, which already counted as the largest single-session increase since 2009.

It was difficult to find the right adjective to convey the gravity of the two-day move at the front-end. At one point, the two-session increase was ~60bps. As far as I can tell, the last comparable episode was four decades ago.

The figure (above) illustrates the magnitude in the context of the last two years.

I assume most readers are familiar with the dynamic. This is a tradition at the Journal. Fed whisperer articles are presented as recaps of recent public speaking engagements and other preexisting messaging. Technically, the articles contain no “new” information, but they’re widely viewed by market participants as leaks. That’s especially true when officials want to avoid blindsiding traders, but don’t have time to socialize the message. Bottom line: 75bps is on the table for Wednesday’s meeting.

The figure (below) illustrates the severity of what I think it’s fair to call an escalating crisis of confidence, but I’d emphasize that this is what the market needed. The slow bleed in equities and the tension in rates following May’s CPI report were indicative of extreme uncertainty about the Fed’s decision calculus. The Committee needs to address that uncertainty by (ironically) reclaiming their right to act without the market’s consent.

The near-term pain from a 75bps move (and, perhaps, aggressive messaging from Powell at the press conference), may well be acute, but markets will be better off for it over the medium-term. Or at least that’s my take.

Of course, the Timiraos story didn’t guarantee a 75bps increment this week. But it was most assuredly an indication that such a move is on the table and will remain so for July.

After flirting with the magic threshold for weeks, the S&P officially closed in a bear market on Monday (figure below).

The dollar surged and swaps priced a jumbo hike as a coin flip. Terminal rate pricing reached 4%.

“In the event the Committee errs on the side of predictability and delivers 50bps, there is little to justify two-year yields close to 3.25% other than the prospect for the Fed to, once again, need to play catch-up with faster hikes later this summer,” BMO’s Ian Lyngen and Ben Jeffery wrote. “While we’re certainly sympathetic to the optics of the Fed appearing behind the curve, larger rate increases at this juncture would primarily be symbolic and have a greater influence on breakevens and forward inflation expectations than actual gains in consumer prices during the coming months.”

I’d agree with that assessment. But the battle against inflation is already lost. The Fed is fighting the war now. If they want to win, they need to short circuit the expectations channel before it’s too late. 75bps would be a good start.

Read more: Volcker Or Bust: What To Expect From June’s Fed Meeting

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12 thoughts on “Markets Brace For Impact As Fed Whisperer Tips 75

  1. … and yet, at the end of today (6/13/22), the S&P 500 is ~12% higher than its pre-pandemic record level and ~54% higher than 5-years prior.

    1. Doesn’t an average of about 7% a year sound fine? (Between AI, electric vehicles, LEO satellites, telemedicine, CRISPR, etc. it does feel like there is value being created?

  2. @RIA,

    “FOMC is going to hike us into a nasty recession.” A recession, I think is very likely. Whether it is a “nasty” recession depends, I think, on whether the Fed keeps hiking when the recession emerges, or backs off.

    That depends, I think, on whether inflation has responded to the hikes up until then, and if not then on whether the Fed prioritizes fighting inflation or preserving jobs. I think there is a plausible scenario in which by fall, the Fed chooses jobs over price stability.

    “Oh well. There will be opportunity in the wreckage.” The key thing, I think, is that we don’t need a nasty recession to see SP500 near 3000. Rates +100bp more and a mild recession would, I think, be enough.

  3. “FOMC is going to hike us into a nasty recession”.
    The determination of whether the recession is relatively mild or nasty will likely be determined by the “race” against the depletion of still very high levels of excess cash currently held by households, non-financial corporations and banks vs. rising unemployment (which will break the Fed’s hawkish tilt).
    On an aggregate basis, households hold enough cash to pay off household debt- but of course, who knows if the ratio is 1:1 within each household.
    I am leaning towards something less than nasty because the Fed would rather be cutting (adding to the punch bowl) vs. raising (taking away the punch bowl)- so as soon as unemployment starts to rise, the Fed will, at a minimum stop raising/reducing liquidity.

    1. Thanks for the insight.

      I can’t see them stopping before people start hating stocks and swearing them off for life. Now that people who used to not participate in markets learned the trick to get rich quick, I don’t see money printing making a cameo for at least a decade.

      1. As RIA said, there will be opportunity in the wreckage. But I disagree with money printing not making a cameo for at least a decade statement. I’d say within 3 years we’ll be back to QE, if not sooner.

      1. Household cash balances (currency, checking, savings, money markets) have increased from $12.7T Q42019 to almost $18T Q12022.
        Non-financial corporations cash balances have increased from $5.2T to $6.7T over the same time period- although, the non-financial corporations’ cash balances seem to have peaked at $7T Q42021.
        Bank deposits are a record $6T.
        Balance sheets seem to be in very good shape.

        1. Yep. All valid aggregate numbers, but very poorly distributed. The devil is in the details

          An edited excerpt from a recent piece I wrote:

          “We’ve seen a breakdown from last January showing median savings by income bracket. Not surprisingly, the median savings for people earning less than $20,000 was $810. More surprising was that for folks in the $60,000 to $80,000 segment the number was only $10,000.

          Another survey claimed that in January 64% of Americans were living paycheck to paycheck, versus 52% in April 2021 when Covid benefits were still being paid out.

          Perhaps as a result, in April bank credit-card balances rose 14.2% from a year earlier, auto loans increased 7.5% and other consumer loans climbed 19%.

          Finally, the savings rate fell to 4.4% in April, the lowest since September 2008.”

          Sorry, but in my humble opinion, that hardly suggests that there is a large pool of “excess” savings for the majority of Americans to run down to support everyday spending.

NEWSROOM crewneck & prints