Investor consensus reversed sharply this week, from the opinion that the Fed would hike twice then pause, to the Fed needs to hike at every meeting until reaching 3.0%. Evidence of the change can be found in the 17 basis point rise in the yield of the two-year note, which is now about 10 basis points below the high of the year.

While the economic data was generally mixed for the week, with the exception of the print on the May employment report, we attribute the consensus change to the meeting between Chairman Powell and President Biden, and comments from the JP Morgan CEO.

Through April, the capital markets took the Fed’s hawkish tone as a welcome antidote to stubbornly high inflation. But as we move further into the year, that mindset has reversed. Driving the change is the barrage of weak earnings reports we’ve seen over the past two weeks, and specifically retail earnings. Amazon, Walmart and Target were the worst of the category, all having their stock price fall by more than 20%. The overriding culprit has been rising costs of goods sold cutting into their bottom line. That was more than enough to undercut the fledgling return of investors confidence we saw as we closed out last week. For this week the S&P 500 is down more than 4% and trading at its lowest level since March 2021.

Last week we flagged the advance report of Q1 GDP as the economic report to watch this week, and we were spot on. Investors were shocked to learn that economic activity contracted 1.5% in the first quarter, driven primarily by trade and government spending. On the bright side, the consumer continued to spend, with the personal consumption measure rising 4.7% over Q1 2021. But a big expansion in imports and reduced government handouts were more than enough to offset the gain in consumption.

The minutes of the recently concluded FOMC meeting are rarely of interest since the Fed adopted the post-meeting press conference during Chairman Bernanke’s term. Since then, Fed Chair’s have chosen to communicate the committee’s thinking at the post-meeting press conference. Chairman Powell didn’t follow that pattern at the March 15 meeting as the minutes contained “bombshell” information. Two days ago Fed Governor Brainard rocked the markets with her comments that the Fed was ready to begin to reduce its balance sheet. That was confirmed yesterday when the minutes loosely detailed how balance sheet reduction was to be implemented.

The vicious bear market in bonds that began last fall continued this week with the 2-year Treasury note touching 2.33% this afternoon. Recall that the 2-year note closed last week just below 2.00%. Fed speakers were again the driver of the selloff, strongly suggesting a 50 basis point hike at the May 4th FOMC meeting and potentially another 50 basis point at the June 15th meeting. Citibank is forecasting four 50 basis point hikes this year, while Goldman Sachs is expecting that the 2-year note will end the year at 2.90%. Those forecasts and retail liquidation of their fixed income holdings is behind the relentless selling. Ironically, equity investors seem to be unfazed by the sharp selloff in fixed income. Since hitting the low for the year in late February, the S&P 500 index has rallied nearly 10%.