The Fed advises the market to accept higher and faster rate hikes
Outlook: Amid talk of the Fed pushing the US economy into recession, yesterday’s Richmond Fed Index was a ray of light – a reading of 13 to 1 in February and when -1 was expected. Trading Economics reports “Increases were seen in all components: shipments (9 vs. -11), volume of new orders (10 vs. -3) and number of employees (23 vs. 20). The order book index turned positive again (7 vs -4). The Supplier Lead Time Index remained high, indicating that most companies were still reporting increasing lead times. Today’s data point is new home sales, barely a market driver and with no expectation of a slowdown.
As will be the theme for some time, the Fed is leading the market to accept higher and faster rate hikes. St. Louis Fed Bullard wants fed funds at 3% by year end, and Cleveland Fed Master wants at least 2.5%, the neutral level, and approves front-loading with increases of 50 basis points. Even San Francisco Fed Daly wants to see the neutral hit and maybe overtake. Powell speaks at the BRI today and Daly and Bullard also have remarks.
Ignoring Powell’s advice to avoid the yield curve, many analysts are stirring up a storm of fear with the curve narrowing and, in some cases, inverting. Bloomberg offers a metric we’ve never heard of: the Bloomberg Global Aggregate Index, a measure of “total returns to government and corporate debt.” He calls it a benchmark, but presumably in the bond boy coterie – not a well-known thing. It recorded “the worst decline in fixed income since at least 1990”, down 11% from the January 2021 peak. The 2008 financial crisis led to a decline of 10.8%. Forgive us for not being impressed. The massive quantitative easing of the past decade has completely messed up the allocation of capital to fixed income securities. It’s still screwed, we are skeptical of any comparison with previous periods because the previous periods had no QE. It’s not the same as saying “this time it’s different”, but it’s like saying “this time it’s not comparable”.
And the FT had a heartwarming story about ‘the yield curve could be wrong’. The yield curve points to recession. “Powell’s speech sparked a spirited 18 basis point rally in the Treasury over two years; the 10-year rose by less than half; leaving the difference between the two at a paltry 19 bps. It left everyone staring gloomily at a painting like this. The blue line, the 10-year/2-year curve, is heading straight for zero. Over the past 40 years, each time this has happened, a recession has followed (as shown in the shaded portions of the chart). In fact, it’s worse than that: Inverted 10/2 curves have preceded the last eight recessions and 10 of the last 13 recessions, according to Bank of America.
But fear not, there are other indicators that aren’t grim. “There is good research by the staff of the Federal Reserve system that really says to look at the short – the first 18 months – of the yield curve. This is really what has 100% of the explanatory power of the yield curve. It makes sense. Because if it’s reversed, that means the Fed is going to cut, which means the economy is weak. And this today is not reversed. So don’t look at the long end of the yield curve. It’s irrelevant because it’s so distorted by EQ.
That doesn’t mean we won’t have a recession at some point. But that probably means we shouldn’t see him hiding in the bushes today.
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