Devil and the deep blue sea behind me

Vanish in the air you'll never find me

I will turn your face to alabaster

When you'll find your servant is your master -The Police

The game has changed, and yet it’s still a game between Jay Powell and Wall Street. The Street has tantrums and selloffs as their primary weapon, and from time to time, the Chairman of the Federal Reserve has the power to jawbone markets to where he wants them. 

The interactions between these forces are often tilted by the action in the bond market, where the spike in yields turned words uttered three weeks ago (Dec 15) from no big deal, as the S&P 500 was up 1.6% to ‘the world is coming to an end’ yesterday. Folks, we already knew the Fed discussed allowing bonds to run off after speeding up tapering and hiking rates, but yields were quiet then and are rocketing higher now. So, at this moment, it’s the alabaster-faced stock market on a white-knuckle ride after finding their ‘servant is their master.’ At least for the moment.

Staff Review of the Financial Situation Over the intermeeting period, rising inflation and FOMC communications appeared to have put substantial upward pressure on shorter-dated Treasury yields. Even so, longer-dated Treasury yields declined, on net, in part reflecting renewed concerns among market participants about the course of the pandemic and associated safe-haven flows. Pandemic-related fears as well as concerns about inflation and tighter monetary policy apparently weighed on risky asset prices despite continued robust economic data. In domestic markets, broad equity price indexes were little changed, equity market volatility increased markedly, and spreads on corporate bonds widened moderately. In AFEs, sovereign yields declined, and major equity indexes edged down. Short-term funding markets were stable, while participation in the ON RRP facility increased further. Overall, financing conditions for businesses and households remained accommodative except for small businesses and nonprime borrowers. Market participants' views on the expected path for the federal funds rate—as implied by a straight read of overnight index swap quotes—suggested that they had pulled forward expected rate increases more into 2022 and 2023 compared with the timing they anticipated at the time of the previous FOMC meeting. The potential for a less accommodative policy stance over the next few years contributed to a notable rise in two- and five-year Treasury yields. On net, inflation compensation had declined moderately since the November FOMC meeting, as heightened concerns about the inflation outlook appeared to be outweighed by increases in the perceived prospects for tighter monetary policy and by fears about the course of the pandemic. Renewed concerns about the course of the pandemic also contributed to a decline in the 10-year Treasury yield, on net, over the intermeeting period despite stronger-than-anticipated data on economic activity and surprisingly high inflation. Broad equity indexes were little changed, on net, since the previous FOMC meeting, as strong economic data appeared to offset concerns regarding monetary policy, inflation, and the pandemic. Spreads of both investment- and speculative-grade corporate bonds widened moderately, and spreads of municipal bonds were little changed. https://www.federalreserve.gov/monetarypolicy/fomcminutes20211215.htm

Just How Late is the Fed?

When Jay Powell bit the bullet and retired “transitory” from the Federal Reserve Lexicon, it was as close to a mea culpa as we could expect. Not sure how much condolence retiring one word means to savers and folks living on fixed incomes. There is no doubt the inflation crisis is lasting a lot longer than the Fed  initially thought, but if there were “word clouds” that revealed true thoughts from folks, one would hover above Powell with one word repeated over and over again:

Transitory

Transitory

Transitory

Yet, I believe Powell still believes this whole inflation thing is transitory – the result of turning off an economy then turning it back on, resulting in ‘demand shock’ that’s still roiling the supply chain.

When the jobs report is released tomorrow, I will first zoom in on participation and then on wages. This is a part of the equation that is not transitory. On the contrary, a lot of states bumped their minimum wage  on January 1^st; some this month will get an extra nudge when reported.

The Fed fund target rate used to move in tandem with median wage changes, but that’s changed this time around. There is no doubt the Fed is behind the curve, and that’s why the timeline for allowing the balance sheet to decrease could happen in a matter of months, rather than the two years the Fed waited last time. Interestingly, their assumption is that household and business balance sheets are so much stronger this time around – but that could change fast.

Nowhere to Hide

When the dust settled, there was nowhere to hide, which is usually the case when a wave of panic washes over the market.

S&P 500 -1.94%

• NASDAQ: -3.34%
• DJIA: -1.07%
• RUT -3.30%
• Bitcoin: -4.57%

Of course, the market breadth was awful, but I’ve seen similar numbers in up sessions.

Market Breadth	NYSE	NASDAQ
Advancing	660	960
Declining	2,701	3,712
52 Week High	129	121
52 Week Low	109	379
Up Volume	1.04B	1.03B
Down Volume	3.01B	3.37B

Bond Yields & Real Yields

This is what we’ve been waiting for since late March 2021. Instead, the ten-year bond yield is nearing a double top. The current momentum would suggest a clean break and move toward 1.80%, but we’ll see.

Meanwhile, the real bond yield (adjusted for inflation) is still negative, which has some speculating the Fed will have to be aggressive. I’m flummoxed on this, and I am not sure how to read into this other than it’s amazing to me how much money bonds continue to attract. I get this is actually better than other global bond yields, but it’s absurd.

Portfolio Approach

There are no weighting changes this morning in our Hotline Model Portfolio.

Today’s Session

Initial claims rose by 7,000 to 207,000 topping estimates for 195,000. The prior week was revised higher by 2,000 to 200,000.A better gauge, the 4-week moving average, increased 4,750 to 204,500, and the previous week was adjusted up by 500 to 199,750.

Continuing claims increased by 36,000 to 1,754,000 while the 4-week moving average declined by 61,250 to 1,798,750 and is the lowest since March 14, 2020.

The Dow is looking to open higher, while the Nasdaq and the S&P 500 are pointing down, as selling in technology and growth continues. 

Comments

Every now and then I'll err in my trading ways, yet jay does it way to often............ Patrick J Pedley on 1/6/2022 3:52:07 PM

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