3/24/23 – Michael Barr, the Fed Vice Chair for Supervision, prepares for woodshed event!

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.

Simultaneous to his press conference, Treasury Secretary Yellen testified before Congress giving a contradictory message about the willingness of the FDIC to cover all depositors including those with more than $250,000 covered by FDIC insurance.  One would think that in the midst of a banking crisis, the Fed Chairman and Treasury Secretary would compare notes before speaking publicly about the crisis, but apparently that was not the case.

To discern what investors think of the government management of the nascent crisis one only needs to look to the capital markets. The financial sector ETF, XLF, is down nearly 14% this month, and the two-year note is 100 basis-points lower for the period.  Most stunning though, was the movement in the 2-year/30-year yield curve.  That metric, which reached an all-time inversion of -117 basis points a little over two weeks ago is trading at -7 basis points today.  The two’s/bond’s trade, as it is known, is popular among money center banks and hedge funds and the 110-basis point move is likely to result in losses at both.  The question is how bad those losses are, and what impact will they have on bank profits.  With the quarter ending next Friday, we’ll have an idea of the impact in just a few weeks when the banks release Q1 results.

Fed Fund futures traders, like the 2-year note traders, are skeptical that Chairman Powell will raise rates even one more time.  The futures are no longer anticipating future rate hikes and have now assigned a small probability of a rate cut at the next FOMC meeting.  Moreover, the December Fed fund future is pricing in approximately 100 basis-points of rate cuts.

With secondary and tertiary economic data next week, trading is likely to be dominated by the continued obsession with the safety and profitability of the banking sector.  Of special note, Michael Barr, the Fed Vice Chair for Supervision, will testify before Congress on Tuesday and Wednesday and our guess is that politicians on both sides of the aisle will be out for blood.