We thought that the Federal Reserve would have held the overnight rate steady at the conclusion of this week’s FOMC meeting, but we were wrong! The Fed raised the overnight rate by 25 basis-points, taking the range to 4.75% to 5.00%, the ninth consecutive rate hike. In his press conference, Powell essentially said that the banking sector is fine and that markets should expect another rate increase.
Anyone with children under 12 years-old understands the concept of the participation trophy (or has at least watched the Bluey Episode titled “Pass the Parcel”). In an effort to make sure that all participants feel good about themselves, everyone gets a trophy. For the younger kids, quite often the parents discourage keeping score or even declaring a winner. This week felt like it was trophy day for the banking system. The first trophy went to Silicon Valley bank for their mismanagement of their hold-to-maturity book, by establishing a duration that suffered a significant loss of value from the Fed’s draconian rate hikes to date. The FDIC, which guarantees deposits up to $250,000, on Sunday evening announced that the guarantee would be extend to all depositors regardless of the size of their deposit. As has been communicated, many of the deposits were the working capital of promising, albeit not yet profitable, start-ups. Start-ups that should their break-through prove successful, hold the winning lottery ticket to hundreds of millions or billions of dollars.
Friday can be best summed up in the words of Ron Burgundy – “Boy, that escalated quickly… I mean, that really got out of hand fast.”
With Chairman Powell’s testimony before Congress coming just two days before the belated release of the February employment, we expected volatility in the capital markets to spike, but not to the extent that it did on Friday morning. The market panicked when news broke that Silicon Valley Bank (SVB) was experiencing a mass exit of depositors and it’s plan to raise capital through a secondary equity sale had failed. While the bank is on the smallish side, investors panicked and sold bank stocks in a classic “sell the rumor” fashion. Despite the FDIC’s takeover of SVB. The XLF bank ETF fell more than 8% this week, and we wouldn’t be surprised if it took a week or two for financial stock prices to bounce back.
It was fleeting, but for a few hours on Thursday the 30-year bond traded above 4.0% as bond investors debated whether the Fed has again fallen behind in battling inflation. The bout of selling reversed itself on Friday, with the long bond closing out the week unchanged. Fed Fund futures, on the other hand, continue their upward march and are now forecasting a peak rate of 5.45% in September of this year.
This holiday shortened week was free from the wild, unexpected economic data we’ve been seeing since the start of the year. Activity continues to surprise to the upside as has the inflation backdrop. Existing home sales fell -0.7% from last month’s measure, while the second look at Q4 GDP was revised lower to 2.7% from 2.9%. The most eye-popping of the week’s data, the Personal Consumption Expenditure price deflator, the Fed’s preferred measure of inflation, rose 5.4% year-over-year. That measure, when paired with the above expectation CPI released mid-month has taken the steam out of the nascent bond rally that started the year.
This week’s economic data was far worse than we had feared! We had hoped that 400 basis points of rate hikes would have slowed the economy and eased the rate of inflation, but to no avail. The January consumer price index, month-over-month, registered 0.5%, and 6.4% on a year-over-year basis, outpacing consensus expectations.
As we wrote last week, the tone of Chairman Powell’s comments during the post-FOMC press conference left observers with the sense that the Fed was close to a peak in the overnight rate. That view was immediately undone on Friday when the BLS reported that 517,000 jobs were added to the economy in January. Certainly not the outcome expected of an economy teetering on the brink of recession. To counter Powell’s comments, Fed speakers this week resounded their hawkishness. The “jawboning” worked with the 2-year note rising 40 basis points from last week’s low yield. The 30-year yield also rose, but by about half of the 2-year move. The overnight/30-year spread remains inverted and is closing the week at about -80 basis points. As we’ve mentioned before, an inverted yield curve has a negative cost of carry for levered investors. The risk is that those investors tire of the expense and exit the trade causing long rates to rise. Effectively, it’s the inverse of a short squeeze. That realization may have played a role in the disastrous 30-year auction on Thursday. Treasury notes and bonds trade on a when-issued basis for a number of days prior to being auctioned. The practice is useful in that it gives investors a strong idea of the yield level at which the new issue will clear. Yesterday’s 30-year auction had a 3.2 basis point tail. That was a disastrous outcome and equated to about a half point repricing on the bonds bought just before auction.
We thought the lead story for this week was going to be the less hawkish, post-FOMC press conference, but in fact it’s the January employment report. Economists had been forecasting that the economy would add 188,000 jobs in January and the unemployment rate would tick up to 3.6%. Given the increasing number of layoff announcements since December, we thought the actual release would have been about half of the expectation. Instead, the economy generated a staggering 517,000 new jobs during the month and the unemployment rate ticked down to 3.4%. There was no weakness in any of the subcomponents and, to be honest, the report was bewildering.
Fourth quarter GDP registered 2.9% annualized growth, beating the 2.6% expectation, but as is often the case with economic data, the devil is in the details. The growth was driven by rising inventories, government spending, and softening imports. The weakness in imports is mostly due to the Chinese covid quarantine and the resultant slowdown in production. With the Chinese factories humming again, we expect that net imports will revert to being a drain on GDP in the first quarter. Similarly, inventories added nicely to the headline number but that is also likely to flatten this winter. The biggest disappointment in the release was private final domestic demand. The measure of how much Americans wanted to consume fell from 1.1% in Q3 to 0.3% in Q4. That’s a significant slippage in demand, which jibes with the disappointing retail sales registered in the last two months of 2022.
Though it was a holiday shortened week in the U.S., there was plenty of action in the markets. The most significant market-moving news was the Retail Sales report for December. Recall that November retail sales were disappointing, worrying analysts that the holiday selling season was going to be a bust. That worry proved prescient! Retail sales for November were revised down from -0.6% to -1.0% from the October level. On Wednesday the government reported that December retail sales fell -1.1% from the revised November figure. Parsing through the details, the weakness was broad-based, with sales at department stores falling a shocking 6.6% from November’s level.