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 of the inflation fight. The alternative read was that job creation is slowing, wage growth is still cooling and with layoffs mounting and (revised) claims rising, a turning point is just around the corner.
Whatever the case, two year-yields were cheaper by a dozen basis points, bear flattening the curve, and pricing for the May meeting firmed up a bit.
This was into a thin market, so it’d be a mistake to read too much into it.
I’d be remiss not to mention that Nick Timiraos published a piece Thursday called “Latest Fed Increase Came Down to the Wire. ‘That Was a Rough Weekend.'”
“Fed Chair Jerome Powell and his colleagues faced their closest call on interest rates in years,” the very first sentence read. “It wasn’t until the clock was ticking down two days before their scheduled decision last month that senior leaders settled on a plan to lift them by a quarter percentage point,” Nick added.
At the least, that underscored Powell’s press conference remarks about the Committee having considered a pause, and I think it’s fair to suggest the May gathering will likewise come “down to the wire,” albeit not in the same way March’s decision did. Hopefully, there won’t be another shock threatening to destabilize the system ahead of next month’s meeting, but barring a big upside CPI surprise, the argument for “one more” probably won’t be that much stronger than the case for a pause.
That said, market participants should consider two things:
- A pause in May pretty much means the cycle is over. The market is already priced for cuts commencing shortly after rates peak, so the idea of pausing and then restarting in June (or July) would introduce even more confusion into an already convoluted situation.
- The Fed hasn’t taken rates above 5% yet. And there’s still plenty of support on the Committee for doing just that. Indeed, it almost seems like a psychological obsession for a few members.
So, while I think the “coin toss” pricing for May makes sense, you have to believe the Fed would rather get one more in even if it’s a “just because” or “just to say we did” sort of thing.
And that introduces yet another problem: If there’s no real policy case for another hike (i.e., if 25 more basis points isn’t going to make any difference one way or another, particularly considering likely economic drag from tighter credit standards going forward due to residual bank stress for smaller lenders), then why do it? You’d have to ask a hawk.
“There is always a delay between announcement of layoffs and the actual job losses happening that results in an unemployment benefit claim,” ING’s James Knightley remarked, commenting on jobs as a lagging indicator. “In addition, several states require all severance payments to have been finalized before a benefit claim can be lodged, which further extends the time frame [and] on top of that, not everyone will immediately lodge a claim,” he added. ING still expects a 25bps hike next month, though, even as Knightley suggested the Fed will be forced to “rapidly revers[e] course later this year.”
“Taking a step back, the March BLS data showed the smallest private-NFP gain since the series dropped -258k in December 2020, average hourly earnings came in at the lowest yearly pace since June 2021 (with the three-month average monthly gain at just +0.26%) and the labor force participation rate is back to March 2020 levels,” BMO’s Ian Lyngen and Ben Jeffery said Friday, adding that although March CPI will ultimately dictate whether May is a hike or a pause, “Powell and co will surely be on Etsy this holiday weekend ordering artisan inspired, FOMC-themed, ‘mission accomplished’ banners for this summer’s company picnic.”
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.