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Hike In May And Go Away?
For what it's worth, which wasn't much on a holiday Friday, the market reaction to March's nonfarm payrolls report was hawkish.
Treasurys fell sharply in the wake of the numbers, which suggested the Fed probably will have the macro leeway to squeeze in another rate hike this cycle, if that's their preference.
The headline NFP print was robust, even as it showed the expected deceleration, and the pace at which hourly earnings are increasing remains uncomfortably high, or at least in the context
Great title lol
I don’t have a perfect memory of the twists and dips, but my general sense is that since the Fed’s tightening campaign started, the market (rate futures) has persisted in betting that the Fed will stop sooner and lower than dot plots have indicated, while the Fed has persisted in doing, well, what it said it would do. So here we are with FF set to pierce 5% in May 2023. Market has been “very wrong”.
Assuming May is the last hike, which seems reasonable as FF + the bank credit tightening factor will be squarely above inflation, the market will probably persist in betting that the Fed will start cutting sooner and faster than dot plots indicate, while the Fed will probably persist in doing, well, what it says it will do.
The Fed won’t want to risk throwing away 17 months and 500 bp of tightening, without getting what it wants, including all significant components of inflation decisively and sustainably back in the 2% box, labor markets in balance, and the most dangerous excesses squeezed out of the economy.
It takes a lot to force the Fed off its chosen course. In 2021, it took CPI soaring toward double-digits before Powell et al were compelled to cry Uncle. In 2023, what similar irresistible force will budge the immovable object? Regional bank crisis? Nope, that got handled in a couple weeks. UE rising, spending falling, asset prices declining? Nope, Powell has all but told the market he expects these, in that you-can’t-make-omlettes-without-breaking-eggs way.
Exactly what, if anything, will force the Fed to capitulate to the rates market and prematurely cut rates this year, I wish I knew. Clearly a major breakage of the financial system would, so we need to watch for that. After looking more into CRE, I don’t think that will do it (the amount of bank-held office-secured CRE debt maturing in the next 1-2 years is just not enough).
If, by the end of 2023 short rates are about where they are exiting May, the market will have been “very wrong” again.
The first instance of being very wrong had significant consequences – basically the 2022 yield-and-multiple-led asset price decline. I wonder what the consequences of the second instance of being very wrong will be?
JL – isn’t it premature to raise the all-clear flag on the regional banks?
But isn’t the bigger issue what will drive growth going forward in the face of tightening credit conditions? And would the predictable Fed tolerate it before we reach their 2% inflation target?
Dodging disaster is only the first step.
“Higher for Longer”: if the Fed have leeway to raise a bit more now they ought to, they’ve pumped liquidity in via bank “not-bailouts” – reached stablr and somehow they need to vacuum it out quickly.
What I wonder about is to what extent the flood of funds going into money market accounts itself functions to lower short term interest rates. Those funds need to buy increasing amounts of short term instruments including treasuries as the cash comes in. Might that not increase pressure on the Fed to move the other away?
I think much of the flood to MMF is being soaked up by ON RRP before hitting T-bills.
I guess one could track the holdings of some large MMFs to see if that’s true.
I wonder if they would ever consider a 1/8 point hike? It’d be a natural, conservative way to split the difference between wait-and-see-but-risk-pausing-too-soon and over-tighten-risking-a-hard-landing.
For almost all regionals, I think the challenge will be earnings (I think 2023 consensus should get cut big) rather than liquidity (BTFP) or solvency (long rates down).
For credit, I think the biggest impact will be on those reliant on small bank lending (SMB, CRE, construction) and the smallest on those using large banks and bond market (large corporates).
As for the Fed, since there is almost no pain (other than inflation) in the economy now (UE 3.5%, corp pft near record highs, asset values ditto), I think there is quite a ways to go before hitting wherever their pain threshold is.
The economy is weakening so slowly that I doubt we hit that threshold this year.