The Fed left rates unchanged and reiterated its monthly purchasing program of $120.0 billion in treasury and mortgage-backed securities.  But Jerome Powell had his work cut out going into his press conference yesterday.  For the most part, he stuck to the script, even with visible bristling at certain questions, especially those questioning unity at the Federal Reserve.  That’s because the so-called Dot Plot saw four members seeing higher rates in 2022, and seven indicating as much for 2023. 

But many on Wall Street anticipated a much larger shift in the dots in what would have been viewed as an open revolt and rejection of Powell’s dovish plans.

Threading the Needle

Jerome Powell had to acknowledge the economic momentum seen since the last FOMC gathering in December 2020.  With that momentum, there will be inflationary pressures. Powell is confident those will be transitory.   This has been the real contention element manifested in the recent action in both the bond and equity market.  

Back in December, the Fed modeled for 1.8% inflation this year, but now it sees it rocketing to 2.4%, which is well above their 2.0% target.  Moreover, core inflation is also seen climbing to 2.2% before slipping back to 2.0% in 2022.  If Jerome Powell is right, we’ll have a massive boom followed by a reasonable pullback. 

It sounds like a good deal, if that’s the way it plays out.  

GDP	2020	2022	2023
March 2021	6.5%	33%	2.2%
December 2020	4.2%	3.2%	2.4%
Unemployment Rate	2020	2022	2023
March 2021	4.5%	3.9%	3.5%
December 2020	5.0%	4.2%	3.7%
Inflation	2020	2022	2023
March 2021	2.4%	2.0%	2.1%
December 2020	1.8%	1.9%	2.0%
Core Inflation	2020	2022	2023
March 2021	2.2%	2.0%	2.1%
December 2020	1.8%	1.9%	2.0%

So, When Would the Fed Hike Rates?

In the tug of war to get the market to bite, Jerome Powell found the right answer when he laid out these three criteria:

• Maximum Employment
• 2.0% Inflation
• Sustained Inflation

Later, admitting the first two would be based solely on data (no guessing like in the past), and the last is more about gut feeling or expectations, which explained the moves in the Dot Plot.  Here’s the rub; the Powell Fed sees max employment as “board-based and inclusive.”

Board-Based and Inclusive

When the Fed was trying to orchestrate an economic rebound during the Great Recession, rates remained unchanged from December 2008 to December 2015. 

Key employment metrics that gave then Fed Chair Janet Yellen the greenlight:

• 5.0% Unemployment Rate (U3)
• 9.9% Unemployment Rate (U6)
• 62.6% Participation Rate
• 59.5% Employment – Population Ratio

If I am reading Powell correctly, and I’ve heard and read everything he’s had to say in his own personal journey as Fed chairman, he wants to achieve much lower unemployment rates for Black and Hispanic Americans before adjusting policy.

There is no doubt, if overall unemployment was 8.3%, past Federal Reserve heads would not have hiked rates.  The challenge is the Fed is modelling for 3.5% unemployment in 2023, and that still will not move the needle enough across the demographic range for the Powell Fed to act. 

That would invite significant inflation to seep into the economy, and maybe, the Fed would be powerless to stop it before there was too much damage.

Demographic Dec 2015	Unemployment Rate	Participation Rate
White	4.5%	62.7%
Asian	4.0%	63.0%
Black	8.3%	61.5%
Hispanic	6.3%	65.5%

Market’s Cautious Applause I Market Cheered with Guarded Enthusiasm

The market rallied during the press conference, but it didn’t really take off.  I have always said, the real assessment of FOMC decisions and subsequent press conference is the next day session.

S&P 500 +0.29%

• 11.9 billion shares were well below the 14.2 billion daily average over prior 20 sessions
• 44 New 52-week highs versus 0 New 52-week lows

NASDAQ +0.40%

• 124 New 52-week highs versus 18 New 52-week lows

Dow Jones Industrials +0.58%

Ten Year Yield 1.637%

S&P 500 Heat Map

Portfolio Approach

There were no changes in our Hotline Model Portfolio yesterday.

Today’s Session

Powell Has 3…2…1

Overall, this was Jerome Powell’s best FOMC press conference, as he deflated questions that took him all over the map, including opinion on herd immunity.  But Powell didn’t address key issues, including the fate of SLR, and that has not gone unnoticed by the bond market.

In the aftermath of the financial crisis, banks were required to hold equity to 5% of total assets.  This supplemental leverage ratio covered all assets, but last year, the Federal Reserve allowed banks to exempt cash and treasuries from the equation.

That exemption expires at the end of this month, and there is a great fear banks will choose to sell treasuries, which would put more upward pressure on bond yields.  Jay Powell has appeared reticent on what to do about SLR in part because of political pressure.

On February 26, Senators Elizabeth Warren and Sherrod Brown wrote a letter to regulators to restore SLR as quickly as possible.   At this point, if the Fed does not extend the exemption, they will need another more elegant solution.  Some believe increasing the counterparty cap of $30.0 billion in the overnight reverse repo market could do the trick and keep those treasuries off the market.  

I suspect the bond market will keep up the pressure until the SLR issue is resolved.  Powell must act sooner rather than later on this if he wants his grand gambit to be successful rather than blowing up on the launching pad.

10-Year Treasury Yield

Market

Cyclical and reopening names will benefit big time from continued rotation out of mega growth stocks, as buyers are looking to have it all: safety and big gains.   For the most part, the trade is sold as “value.” But the fact is they are overpriced unless going out a couple of years, which is fine.  In fact, I have seen this for most stock winners over the past few years.

It’s a paradigm shift that probably makes more sense for investors and could take some of the volatility out of the market if accepted by the establishment that is focused on next 52-weeks.

Initial Jobless Claims

Initial jobless claims edged higher to 770,000 well above consensus of 710,000 and a reminder that the employment picture is very troubling.  This is the part of the official Fed’s dual mandate (employment and inflation) that gives Powell room to be more accommodative.

Stock of the Day

William Sonoma (WSM)

• Revenue +25.7%
• Ecommerce +47.9%
• Same store +25.7%
• Gross margin 42.1 +450bps
• Increased dividend 11%
• Authorized $1.0 billion
• Early repay $300 million debt
• Accelerated path toward $10.0 billion in annual revenue and 15% operating margins

These brick and mortar retailers that have strong ecommerce are acting great and have more room to the upside.

Keep in mind, the S&P 500 is at an all-time high and the NASDAQ is only a few percentage points below its all-time high.

BE COOL

DON’T PANIC

LOOK FOR OPPORTUNITIES

Comments

Excellent summary this morning on the Fed's day yesterday. Bond yields rising strongly...we'll see if it continues. Chair Powell was pretty direct yesterday on holding pat. Thanks for the detailed commentary Charles! Trev on 3/18/2021 11:16:35 AM

With the government we have I don't admire or desire to have Powell's job, at all! Lorin K on 3/18/2021 12:10:29 PM

All this sounds good and balanced as a strategy! The problem is we have an economically illiterate administration and they will compound their errors on the economic front with ill thought out and over burdensome polices and bureaucratic process orders for regulations! Then they will increase Taxes to try and fill the holes are digging with wasteful spending and non productive/un-needed payments to their Democratic supporters. Old school Democrats understood that shifting resources to the public sectors required a deft approach to the capitalistic entrapanuerial sector that would pay for it all. Today's progressive socialist Democrats just want to play Robin Hood pretending it will be only the "RICH" they soak when in reality they will reach all the way down to the average working Family ( 2 wage earners) and the middle class will feel the impact as well. Amazes me how elitist have such distorted views of how a society and economic system can function for the benefit of all! garro on 3/18/2021 6:54:54 PM

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