Hawk Squawk

Hawk squawk.  There is an old Wall Street line (yes we have many of them) that says “don’t fight the Fed”.  What it means is that if the Federal Reserve is easing rates, bonds and eventually stocks will rally.  It is worth stating the obvious that if the Fed is tightening credit (aka pressing on the brakes), bonds will sell off and eventually, you guessed it, so will stocks.  This rule has stood the test of time, however this past recovery is somewhat different for three principal reasons: 1) rates were held around 0% for an unprecedented amount of time after the financial crisis, 2) quantitative easing, through which the Fed purchased an unprecedented amount of securities in the open market thus propping up markets, 3) an unprecedented amount of transparency, data, and commentary from the central bank.  Notice the intentional use of the word “unprecedented”. The recession that began in December, 2007 and technically ended in June 2009 was unique in that it was accompanied by a collapse of the financial system.  At the time, mainstream economists had no tools to reconcile the crisis which prompted the Fed, the Treasury, and the Executive Branch to come up with a new way to stage a recovery.  Ultimately monetary easing, quantitative easing, and fiscal stimulus pulled the economy back onto its feet, albeit slowly. What ensued was an extended expansion that turned out to be the longest in history.

As mentioned above the recession technically ended in June of 2009 and while the economy has been growing ever since it has only really started to heat up in recent quarters with unemployment at record lows and GDP growth near record highs. The Federal Reserve’s job is to avoid inflation and ensure healthy employment.  Check and check.  Inflation, though it has picked up a bit, is not yet in the danger zone and slightly above a level that Fed deems to be healthy.  But we have to remember that the Fed’s job is to anticipate and prepare for inflation rather than respond to it.  Inflation is caused when economies heat up and if you haven’t noticed the numbers all you need to do is read the President’s twitter feed on which he highlights the record breaking health of the economy.  The Fed has been raising rates slowly since late in 2015 and the slow pace of the hikes has not yet had any material impact on economic growth.  In fact there is an ongoing hot debate about what level of interest rates would be considered to be restrictive to the economy.  Up until recently the rates were thought to be still “accommodative”, which means that they are not expected to slow economic growth.  Currently, many believe that we are right around a neutral rate and further hikes would make rates “restrictive”, which means that their level would slow the economy.  Yesterday, the Federal Reserve released the minutes of their last meeting and they detailed the Fed Governors debating whether or not to begin to push rates into the restrictive zone, with several of them being vocally in favor.  What that means is that if the economy continues to post strong growth, the voices in favor of restrictive rates will start to grow and that they most likely are not far off.  The FOMC will meet two more times this year, once next month and again in December.

Though a hike is not expected in November, there is currently an 83.5% probability of a 25 basis point hike in December.  So despite the recent Presidential jawboning in which he refers to the Fed as being “loco”, the independent Fed will continue to raise rates to keep the economy in check.  Though yesterday’s release was hawkish, stocks largely shrugged it off closing roughly unchanged except for the Dow Jones Industrials which closed down 91 points on the session after having rallied back from an earlier deficit of over 300 points.  Ultimately the Dow’s off day was attributed to a bad earnings release from its member IBM and a downgrade of Home Depot, another member.   That said, around 10% of S&P 500 earnings have been released so far and a greater than average number of them have beaten expectations.  Despite the large gains on Tuesday, the S&P 500, the Dow, the Russell 2000, and the NASDAQ 100 all remain risk off.  Bonds traded off yesterday and ten year treasury yields ended the session up around 3.20%, edging closer to their recent 3.25% high which caused much stress and media discourse in prior weeks.

Today we are due to receive the Philadelphia Fed Business Outlook, which is a regional health indicator and it is expected to come in at 20 after last month’s 22.9.  Later this morning the Conference Board will release its leading indicator which is expected to show a month over month growth of +0.5 after last months growth of +0.4.  Today will also feature some Fed speeches which may get some attention in the wake of yesterday’s release.  Finally, we have number of corporate earnings expected before the market opens which should be the real news of the session but the news cycle will most likely continue to be dominated by the Fed Minutes and Canada’s Cannabis legalization.  Stock futures traded off a bit overnight and the VIX is just under the magic number 18, so we can expect some more volatility in the session ahead.

daily chartbook 2018-10-18