It started quite well: milliseconds after the release of the Fed statement and associated Fed balance sheet “principles,” the algos quickly skimmed through the key points before realizing there were no landmines in the statement: indeed, all of the biggest hawkish fears had been defused, with the Fed not announcing an early end to tapering, an early start to rate hikes and certainly nothing on fears of a 50 basis point rate hike.
Elaborating on the statement, the Committee announced the last two reductions in the amount of their monthly asset purchases, which end purchases “early March” and Committee now expects it will be “soon appropriate” to raise funds rate – which will almost certainly happen at the next FOMC meeting in March – and updated the statement to note that inflation is “well above” the FOMC’s 2% target (previously characterized as “having exceeded 2% for some time”) and that the labor market is “strong”, dropping the judgment that the economy is not achieving full employment.
Separately, the Committee issued a new set of normalization principles to reduce the size of the Fed’s balance sheet. The principles state that balance sheet reduction will begin “after the process of increasing the target range of the federal funds rate begins,” implying that the Committee can decide to begin normalization at any meeting after March. This contrasts with the normalization principles of the previous cycle, which stated that balance sheet reduction would begin “once the normalization of the level of the federal funds rate is well underway”. Although the Committee did not specify a pace of normalization, the principles note that the Committee intends to reduce the size of the balance sheet “primarily by adjusting the reinvested amounts of principal repayments”, suggesting that active sales of assets are unlikely as part of the balance sheet. reduction. The Committee also noted that it “intends to hold primarily Treasury securities” in its balance sheet over time.
So far so good, as there was nothing here that the market hadn’t anticipated or priced in.
And then Powell started talking… and all hell broke loose, as stocks, bonds and gold all fell after the Fed as the dollar rallied.
So what exactly did Powell say to upset the algos so much?
Well, a few things, starting with Biden’s admission that the Fed is launching the most historic tightening cycle with virtually zero visibility, when he said “the outlook is pretty uncertain.”
Paradoxically, when it came to the pace of rate increases, Powell was evasive… which isn’t hawkish per se. But as Bloomberg notes, the market might have trouble interpreting this, as the presumed pace is once per quarter. This could leave the door open for a more aggressive path than currently planned. But that could imply a willingness to pull back if downside risks suddenly materialize.
That said, Powell apparently had enough Visibility to Provide Soft Advice: Asked if rate hikes can reduce inflation without hurting the labor market, Powell sounded optimistic and made a comment that immediately took stock markets’ breath away by inadvertently signaling or not, a longer tightening cycle than expected: “I think there’s quite a bit of room to raise interest rates without threatening the labor market.”
Powell continued his doublespeak…
“The economy no longer needs high and sustained levels of monetary support.”
“Of course, the economic outlook remains very uncertain.”
And for those hoping for the Fed Put, Powell dismissed that idea as if it were close:
“Asset prices are somewhat elevated,” said Powell.
They no longer pose a threat to financial stability, he says.
But the straw that broke the camel’s back was when Powell admitted that the Fed is “willing to act sooner” and “perhaps faster” than last time to reduce the balance sheet. adding that “we want the balance sheet to decline in a predictable way”, adjusting the reinvestment of maturing debt, in an attempt to calm the panic.
But that didn’t help as stocks all vomited in the red for the day (and week), only to rebound the moment Powell stopped talking…
Relief rally that Powell eventually shut down
— zerohedge (@zerohedge) January 26, 2022
And yes, we have another historic milestone: the S&P 500 erased a 2% lead for the first time since April 2020 and was down 0.3% at the close. The Nasdaq desperately managed to come back unchanged that day…
This is the market’s worst performance on an FOMC day in at least a year…
In his Powell presser post-mortem, Bloomberg intelligence economist Carl Riccadonna said the market’s reaction to the presser (especially movement in the short end of the yield curve) appears to be signal-dependent. Powell said they’re going to do more on the interest rate front initially, especially since Powell said the committee hasn’t yet defined the balance sheet liquidation plan.
Echoing that sentiment, Alex Chaloff, co-head of investment strategies at Bernstein Private Wealth Management, notes that a hawkish-sounding Powell is driving the selloff, and identifies this remark from the Fed Chairman as giving the your : “I think there is plenty of room to raise rates without threatening the labor market. Chaloff concludes:That’s bold for someone as cautious as Powell.
Others were even more critical: Jason Brady, president and CEO of Thornburg Investment Management, said that “many commentators have argued that the Fed doesn’t want to ‘surprise’ the markets. I think this is both true and regrettable. It is precisely by giving the markets what they want in the short term that the Fed has put itself into a corner. »
Of course, it’s possible that Powell was simply ignorant instead of telegraphing to the market what he was going to do. This certainly takes into account that financial conditions have tightened significantly since the Fed’s hawkish pivot last November – with much of the Nasdaq (and S&P) now in a bear market – and this is certainly factored into policy makers’ assessment of the appropriate pace of standardization.
Indeed, as Bloomberg put it, “A predictable normalization path should help stage an easy landing, but if financial conditions tighten too sharply by then, particularly in credit markets, the Fed risks a downturn. ‘induce a more pronounced economic downturn than it would deem desirable.
But for now algos sell first, ask questions later as confirmed by the market’s dismal reaction to Powell’s presser, manifested not only in the vomiting of risk assets that wiped out all intraday gains and are now down that day, but also in the collapse of much more worrying and pre-signal of the recession in the yield curve.
Bonds were a bloodbath, with the short end underperforming dramatically…
This is the biggest jump in 2-year yields since March 2020…
Rate hike expectations have increased slightly at the shorter end (March fully integrated), but for December 2022, rate hike expectations have increased significantly with 50% chance of a 5th hike this year now…
The yield curve has flattened considerably – some may collapse – to its flattest level since April 2020…This screams that a Fed policy error is imminent.
The dollar jumped above yesterday’s highs, returning near its highest level of the year…
Bitcoin was pumped and dumped after the Fed, hitting $39,000 before falling back below $37,000…
Gold was pummeled like a baby seal as the dollar ripped off…
Real yields (rising) have recoupled with gold for now…
Oil prices remain higher, despite post-Fed weakness as geopolitical tensions dominated. WTI pulled back above $87 intraday – its highest since October 2014…
Finally, note that a stock market crash is unlikely to help the situation in this chart…
Stocks will continue to tumble until Biden’s approval rating rises
— zerohedge (@zerohedge) January 26, 2022
Also, Bloomberg’s Ye Xie raised the specter of Powell’s rookie mistake in 2018… At the time, his hawkish comment that Fed policy needs to ‘go beyond neutrality’ and ‘we are far from neutral at this point, probably” caused turbulence in the markets. Well, this comment today probably took the euphoria out of the stock market:
“I think there’s quite a bit of room to raise interest rates without threatening the labor market.”
It certainly wasn’t music to stock market investors then and it probably won’t be now either.
It’s time to unleash FedSpeak!