Daily Brief For May 4, 2023

Fed hikes, signals wait-and-see.


The Federal Reserve moved the fed funds target rate by 25 basis points to 5-5.25%. They also indicated a likely pause.

“Over the last 30+ years, every time fed funds were raised above the levels of core sticky inflation, policy turned out to be restrictive enough to cool inflationary pressures back to 2% or below,” explained Alfonso Peccatiello. “By summer, core sticky inflation should be trending in the 4% annualized area while fed funds will be sitting at 5% – and history suggests that means the Fed has tightened enough.”

Graphic: Retrieved from Bloomberg.

Following a wait-and-see period, which Peccatiello thinks may last about five months, Powell said rates might loosen; measures indicate that financial conditions are tight, leading to predictions of negative economic consequences and cuts.

Graphic: Retrieved from Bloomberg.

“Chairman Powell’s message remains sobering — the Fed’s policy rates will only come down with a greater economic slowdown or credit crunch from tightening bank lending standards,” said Yung-Yu Ma of BMO Wealth Management. “The equity market has faded in the wake of Chairman Powell’s press conference. The market may be realizing that there’s a fine line between getting the rate cuts it wants and maintaining an economic trajectory that doesn’t invoke buyer’s remorse. A classic case of be careful what you wish for.”

Graphic: Retrieved from Charles Schwab Inc-owned (NYSE: SCHW) thinkorswim platform. Three-Month SOFR Futures (FUTURE: /SR3). Implied interest rate = 100 – future price; the implied interest rate calculated using the 3-month SOFR future is an annualized rate. Based on the shape of the curve, /SR3 trader’s price an easing in the coming months.

Markets closed lower after the Fed’s decision, amid PacWest Bancorp’s (NASDAQ: PACW) examination of strategic options, including a possible sale, confirming that the problem of high bond yields is still around in the banking sector.

Graphic: Retrieved from Bloomberg.

“It looks like the markets are moving from one bank to the other, and vulnerable deer in the herd are being kicked off,” Dennis Lockhart, a former Atlanta Fed President, said. “But I would like to believe that Jay Powell has information that suggests that the situation is contained or containable.”

Graphic: Retrieved from Tier1Alpha. Measure suggests traders’ fears and demands to protect/speculate on movement are higher (but restrained) after rate hike, a pressure on underlying markets that could be a catalyst for upside, too, if volatility were to compress/fall again.

As explained in recent letters and our detailed trade structuring report, the markets may trade stronger for longer. However, the risks grow “as recessionary conditions proliferate.” Some, including Andy Constan of Damped Spring Advisors, think a hard landing is 100% a likely outcome over the long term, while, over the short term, our recent letters point to context that may keep markets contained.

As a reminder, there will be only updates to levels tomorrow and Monday. Stay well.

Graphic: Retrieved from Sergei Perfiliev. A persistent spread in realized and implied volatility may contain markets.


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