The Fed: Is This The End?
In what has been another frantic week in markets we review the Fed Hike & market implications
Hey guys,
It’s been one heck of a week outside of markets.
We hit 1,000 subscribers, so look out for my 1000 sub special tomorrow afternoon!
We’re taking Market Macro Hub to a whole new level, so trust me when I say, you’re macro game won’t be the same.
It’s now just 7-days until the launch, and honestly, I’m excited.
I can’t wait for you guys to see what I’ve poured my heart into the past 12 weeks and more.
But let’s not get distracted, Jay Powell was back at it again, but markets believed otherwise.
Lend me your attention from here on out.
Is This The Pivot?
“we no longer state that we anticipate that on going rate increases will be appropriate to quell inflation; instead, we now anticipate that some additional policy firming may be appropriate.”
—Jay Powell, Fed Chair
This was Jay Powell after Wednesday’s interest rate hike of 25bps.
I read through the press conference report and one thing was clear. Jay Powell will be relying on a tightening in credit conditions to bring inflation down to the target of 2%; rate increases are now his last resort.
Throughout his 43-minute press conference, he referenced “credit” and “credit tightening” 16 times. During yesterday’s press conference, Jay Powell was asked roughly 34 questions, so in every second response, credit tightening was referenced as being a tool to offset inflation.
Our good friend Nick Timiraos, from the Wall Street Journal, asked Jay Powell to explain “to what extent” do your forecasts incorporated today a “material tightening of credit availability”.
Let me explain what Nick is referring to.
Every quarter, the FOMC releases their SEP, (Summary of Economic Projections) four times a year, so every quarter. And in those projections, the FOMC display their forecasts for things such as real GDP growth, unemployment, inflation and of course, the terminal rate.
This is what March 2023, SEP looked like:
Now focusing on the federal funds rate, we can see that the Fed have the terminal rate unchanged at 5.1%, exactly the same as the December projections, which tells me one thing, this is the end of the tightening cycle. Over a month ago, we heard a very hawkish Powell, who was convinced rates will have to go '“higher” for longer; so much so that we had hedge funds purchasing securities that were betting on federal funds rate hitting 6% by September! Crazy right?
Now, this was J Powell’s response:
“there would be some tightening of credit conditions and that would really have the same affects as our policies do”
— Jay Powell, Fed Chair
This further reaffirms my point that J Powell is done hiking, or rather very reluctant to hike interest rates further than where they currently sit at 5.00%.
The real question is, what are markets saying in response?
Let’s start with bonds, where it matters.
Straight to the 2Y, you can see the market is pricing in one thing and one thing alone. Huge cuts in the federal funds rate, even the 3m T-bill is pricing in a 50bps cut from the Fed over the next 3 months.
So if you ask me, investors are on the side that the Fed has hiked until we’ve seen something ‘break’ within the economy, that is the U.S banking sector. With all we’ve seen this past week, Credit Suisse being acquired by UBS, and Deutsche bank, a European bank also under extreme pressure, I believe any more hikes will be the straw that breaks the camel’s back, in this case, the banking system, and wider U.S economy.
Referencing J Powell’s comments on how further tightening of credit conditions would have the same effects as hiking rates, I think it’s worth us taking a look at the NFCI, national financial conditions index, a personal favourite of mine.
For my OG subscribers, you’re familiar with this chart, and the reason I love it is simply due to its sensitivity to changes in financial conditions within the money market, debt, equity and shadow banking system.
Now if you’re new, a simple explanation of this index is this:
Positive values of the NFCI have been historically associated with tighter-than-average financial conditions, while negative values have been historically associated with looser-than-average financial conditions.
Now what we’re seeing since March when we had the banking frenzy is a sharp tightening in financial conditions, and that is expected to spill over into the wider economy in relation to accessing credit/new loans. There’s both good and bad to that point.
The good? As we know, the source of inflation is the excess creation of credit, so if borrowing conditions dry up from the institutional borrowing environment those conditions will also be passed onto the relationship between commercial banks and consumers, which should act as an anchor to bring inflation back towards 2%.
The bad? Tighter financial conditions only put additional strain on already weakening sectors within the economy, and as the banking sector is in focus right now we can only imagine what other sectors may be on the brink of running into a wall.
Bond Market Volatility & The Dollar
This is a very interesting chart below.
The MOVE index is an index that measures bond market volatility within the U.S, similar to how you have the VIX to measure volatility within equities, you have the MOVE index to measure volatility within the bond market.
This month the MOVE index spiked through 2020 Covid highs, coming ever so close to the GFC crisis high of 2008, as a result of SVB, FRB and Signature bank all going under due to the poor risk management of their bond portfolios.
Now let me explain why this is important. Bond volatility is always bad for bonds and markets, mainly because higher volatility increases the uncertainty associated with investing in bonds as heavy fluctuations in the price of a bond also make yields unstable. As a result, investors demand a risk premium to invest in bonds when volatility arises to compensate for the risk of holding onto these instruments.
This past week we’ve seen a positive decline in bond market volatility, which should hopefully continue as investors look forward to a world where the Fed continue to hold tight on any interest rate hikes and we see bond yields stabilise.
The dollar has been on my watchlist and has some more space to the downside as bond yields decline.
If you weren’t aware, bond yields and the dollar have a direct positive relationship.
With both U.S Treasuries and the dollar being a safe haven, when yields are up the dollar is up, when yields are moving south you can expect to see the dollar trading south as well.
It’s currently 7:17 pm as I finish this note, this was a late one on Friday evening I must say but we got there in the end.
The launch.
The new MMH members platform coming this month as well.
It’s got me flat out, but it’s all worth it.
Thanks for getting to the end of this macro report!
I learn more from these 6 minute reads than I do in some of my lectures! You’re getting me through final year! Top man for real 🫡❤️
Thanks again joe!