2/10/23 – Market Rethinks Fed Pivot

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.

While this has been a data-lite week, there was one indicator that stuck out; GDP NOW jumped to 2.15% from 0.67% last week.  GDP NOW is a real time series calculated by the Federal Reserve Bank of Atlanta that forecasts the annualized GDP growth of the economy.  While we’re only about halfway through the quarter, the Fed will likely view that uptick as another indication that the overnight interest rate is still not restrictive enough.

Also released this week were the University of Michigan consumer sentiment indices.  While the various measures of activity and sentiment remained weak, the inflation expectation reading rose to 4.2% from 3.9% last month.  That’s troubling in that it should be going lower at this stage of the tightening cycle.

Next Tuesday the BLS will release the January CPI report.  While the year-over-year inflation is expected to ease somewhat to 6.2% from the 6.5% reported last month, the forecast for month-over-month inflation is an unacceptably high 0.5%.

On Wednesday the government will release the Retail Sales report for January.  Economists are expecting retail sales will bounce back sharply from the disappointing November and December results.  Consensus estimates are for a 1.8% month-over-month gain in the headline number.

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