Bonds on the move ahead of Fed call

There is a tide in the affairs of men. Which, taken at the flood, leads on to fortune”.

Are central bankers taking things at the flood or missing the moment? We shall find out in due course.

Fed Holding Steady

Fed sticks and does not pre-commit to March, but also didn’t rule it out totally– yes inflation is at 2% annualised etc but it’s not well anchored yet and that is what the Fed is working on – the assumption that to cut too soon risks undoing all the good work they have achieved. And why bother; when the economy is humming along as nicely as it is and unemployment is so low? Why risk the inflation demons being unleashed for what – a few extra points of GDP? It would be daft to move quicker than it needs – but it will move quick if it has to – a couple of months of crappy jobs data could move it. And the other thing is that the dovish language in Dec had already created easing in the markets that meant to fuel that message further was unnecessary. It turns out the Fed cannot say anything remotely dovish without the market massively front-running the cuts, which makes it all the harder to deliver those.

The Fed ditched the tightening bias from the statement, whilst pretty much ruling out an early hike in March. It thinks rates will be lower this year. “We believe that our policy rate is likely at its peak for this tightening cycle and that if the economy evolves broadly as expected, it will likely be appropriate to begin dialling back policy restraint, at some point this year,” said Powell. Labour market strength would not delay it from easing when inflation is sustainably at target; but it would cut faster should it weaken. "If we saw unexpected weakening in the labour market, that would make us cut rates sooner,” said Powell. This makes the next few labour market reports of great importance for markets. A nonfarm payrolls report is due tomorrow to help set the scene.

Powell dare not repeat the mistake of the 1970s or a premature celebration of a soft landing. The Fed wants to be more confident of inflation returning sustainably to target and Powell stressed that cutting in March is not the plan. “I don’t think it’s likely that we’ll reach a level of confidence by the time of the March meeting ... I don’t think that’s the base case,” he said. Odds of a cut in March have come down from around 70% at the start of the year to 35%.

Or another take on it is far more facile but no less likely – as demonstrated in 2021, the Fed has no clue how to predict or model inflation or how to influence it so it’s just kinda thinking, inflation is down but we are not sure what happens next so let’s not rock the boat before we feel like we absolutely have to and hope that a) it required rocking in the first place and b) we rock it enough whilst maintaining optionality to rock it some more and c) that we don’t rock it too much.

Market reaction

Stocks fell and the dollar rallied even as Treasury yields declined further for the session. The 10yr dipped below 4% ahead of the Fed decision and extended the decline towards 3.9% as the session wore on and the Fed made its move. That’s maybe the market saying the Fed is going to stay too tight for too long and hurt growth further out the curve. The Dow fell more than 300pts and the S&P 500 ended the day down 1.6% - the comments about the March rate hike basically being off the table did for any risk-on abandon. Alphabet weighed heavily on tech, sliding 7% to drag the Nasdaq down 2.2% for the session despite declining bond yields. Small caps did even worse, with the Russell 2k off 2.6% for the session.

US regional bank stress redux

Banks stocks in the US came under pressure, adding to the risk-off tone, with regionals – remember them! - hit hardest. The KBW regional bank index slipped 6% , the biggest drop since last March. It was all because New York Community Bank shares plunged almost 38% after it reported a surprise loss and cut its divi. Why does this matter? NYCB was the saviour of the failed Signature Bank – and surprise losses like profits warnings seldom come alone. NYCB slashed the divi by 70% to help meet regulatory requirements. The worry is that the end of the Fed’s emergency Bank Term Funding Program, which it announced a week ago would end in March, has been papering over cracks that will resurface upon its closure. The chief exec of NYCB spoke of raising estimate for losses on commercial real estate loans. It’s also the case that the acquisition of Signature raised its assets into a threshold that requires more capital from regulators but you can see the line of descent from acquiring a dodgy bank with dubious assets to feeding fresh problems for banks…and we know what sort of negative feedback loops can occur when bank shares slide and the cost of capital increases. Bring on the cuts pls Jay!

Elswehere...

Tokyo suffered after some hawkishness from the Bank of Japan as the summary of opinions revealed policymakers did discuss an imminent retreat from negative rates. China rebounded a little but broadly Asian shares were struggling for any lift. European stock markets were broadly weaker but not running too hard. Today we look to the Eurozone inflation data and Bank of England – expecting a hold but maybe some softer language than we have been getting? EZ inflation: expected to fall to 2.7% on the headline rate and 3.2% for core, which would be the lowest in two years. If it keeps coming down like this – and without the strong economy to offset – it’s easier for the market to swallow earlier cuts from the ECB.

BoE: Harder for Bailey to be a total Cnut:

The BoE has been a bit more hawkish sounding than the ECB and Fed; less keen to endorse the idea of cuts this year. However with the tide turning it is getting harder for Bailey to play the Cnut – you can easily hold back the waves when the tide is ebbing (and revealing who’s swimming naked), but you can’t so easily do it on the flood. The MPC is fully expected to keep rates on hold, but investors are watching for a change in messaging from the Monetary Policy Committee after sounding pretty hawkish lately. Markets have dialled back expectations for rate cuts in 2024 to around 100bps from 150bps. The task is to guide the market towards where they need to get – likely dropping the reference to “further tightening” from the statement but maintaining the idea that rates will be higher for longer (we’ve already scaled Table Mountain and are enjoying the view). Services inflation remains above 6% and an uptick in CPI to 4.0% mean it’s no time to start cutting just yet. It’s possible the vote moves from 6-3 in favour of sticking vs hiking more to 9-0. The question is whether the Bank stresses the stickiness of the services inflation, which could push back cut expectations.

Shell limits FTSE losses

Shell did a commendable job in dragging the FTSE 100 away from its lows, rallying 1.5% in early trading as the rest of the market followed the US lower. Earnings at Shell beat expectations and the company raised its dividend. Adjusted earnings in the last quarter hit $7.3bn, well ahead of the roughly $6bn expected. Divi raised 4% and a further $3.5bn in buybacks were announced. Despite this the FTSE 100 lost about a third of a percent in early trading as it succumbed to the 7,700 resistance again.