The hawkishness espoused by Chairman Powel last week was repeated on Wednesday and Thursday of this week as Central Bankers from the U.S., Europe, U.K., and Japan gathered in Sintra, Portugal to compare notes on inflation. The remarks offered much more substance than the post-FOMC press conference and Powell’s testimony before Congress.
Hawkishness dominated the conversation this week as Chairman Powell presented the annual state of the economy to Congress. His comments were broadly in line with his post-FOMC comments from last week, with emphasis that the June pause was just that and that the overnight rate is likely to rise further later this year, perhaps even twice. The market took notice, pushing the 5-year Treasury note above 4.0% for the first time since February. Similarly, the April 2024 Fed Fund future traded above 5.00% this week as traders speculated that the overnight rate will remain high into next year.
Chairman Powell must have re-watched the May 3rd post-FOMC press conference and not liked what he saw. Recall that he was called out by CNBC’s Steve Liesman for his tepid answer when questioned about his knowledge of the issues surrounding Silicon Valley Bank. His demeanor at the Wednesday conference was quite the opposite. His first words, delivered in a forceful tone were “My colleagues and I remain squarely focused on our dual mandate…”, as if daring any of the reporters to assume otherwise.
In a week devoid of market-moving news, the S&P 500 continued what some are calling a breakout rally. The index is closing less than 1% below the all-time high of 4325 touched last August. The rally is surprising given that the Fed Funds futures market is anticipating at least one more rate hike by the Fed. The Fed has been in their quiet period this week, so traders were forced to speculate on what may have changed in their thinking. As we closed out the week last Friday, Fed speakers seemed divided on another rate hike at the June meeting. They are going to be challenged to make a snap decision as the CPI index for May is released on the morning of their first day of deliberations.
The best news of the week is that the debt ceiling issue has been resolved, at least until January 2025. The news eased investors fear that a default by the U.S. government would collapse the entire financial system. We won’t have to worry about that again for another 18 months. As expected, the default premium investors built into the front end of the bill curve has entirely vanished and nearby bills are trading near 5% – off the high of 7% touched just two weeks ago.
The Fed paused! Following ten consecutive rate hikes, the FOMC refrained from raising the federal funds rate at the June meeting. The summary of economic projections of the committee members offers some insight into their thinking. Despite leaving the overnight rate unchanged, the committee raised its Fed Fund forecast for the end of this year to 5.4% – 5.6%, an indication that they believe additional hikes will be warranted. What likely drove that decision was the lowered forecast for the unemployment rate from 4.5% to 4.1% and the forecast for real GDP revised for this year from 0.4% up to 1.0%.
Our expectation that traders would overlook fundamental data this week and instead focus on the debt ceiling stalemate proved prescient. The one release that took the market by surprise were the minutes of the May FOMC meeting. Thinking back to the Q&A session that followed that meeting, we interpreted Powell’s comments as closing the door on a June rate hike, but the minutes told a different tale. The Bloomberg story following the release read “Officials were divided over path of rates with more favoring a pause.” “More” is clearly not a consensus and traders immediately took notice and hit the bid in the futures market.
The headline economic report this week was Retail Sales and, for the most part, it told the story of a resilient consumer. The headline result rose 0.4% over the March reading, which you may recall was an abysmal -1.0%, month-over-month. March’s outcome was revised to a simply dreadful -0.7%. On balance, the market ignored the data, choosing instead to obsess about the debt limit impasse. Treasury Secretary Yellen reiterated her concern that the U.S. would default as soon as June 1st if an agreement to raise the ceiling isn’t reached before then. The Treasury Bill market has priced in a default, with early June Bill maturities offering a yield-to-maturity of as much as 5.5%, more than 0.50% higher than Bills maturing a month later. Ironically, the rest of the yield curve, as well as the stock market are trading as though an agreement of the ceiling will be reached. We agree that a deal is most likely to be reached and the market will again return to trading on fundamentals, but as we get closer to the drop dead date, we expect that volatility will rise.