Yesterday, there wasn’t an explicit announcement of a rate pause by Jay Powell & Co., but we got the next best thing with the removal of policy-firming comments in the written statement (below). The committee no longer anticipates that some additional policy firming may be appropriate to return inflation to 2%. Investors were prepared to live with that compromise, but the fly in the ointment came right at the top, where job gains were described as ‘robust’ rather than ‘picked up.’

That makes tomorrow’s jobs report much more important.

Comments by Powell (May 3, 2023):

Economic activity expanded at a modest pace in the first quarter. Job gains have been robust in recent months, and the unemployment rate has remained. Inflation remains elevated.

The U.S. banking system is sound and resilient. Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remain uncertain. The Committee remains highly attentive to inflation risks.

The Committee seeks to achieve maximum unemployment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 5 to 5 ¼ percent.

The Committee will closely monitor incoming information and assess the implications for monetary policy. In determining the extent to which additional policy firming may be appropriate to return inflation to 2 percent over time. The Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.

In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.

Powell Remains Consistent

The market continues to dive under Powell on Fed Days. Generally, the selling begins as he answers the second or third question around 2:45 p.m.

The press conference was a yawner of sorts beginning with Low Energy Powell. His calm word changes were meaningful. There were important moments, however:

Mild recession. I was cracking up watching Powell clear up the misconception that he sees a mild recession. But, of course, the staff came up with that calculation, not Powell, who still believes he is engineering a soft landing.

Debt Ceiling.  Powell hates getting sucked into political squabbles, but after initially punting on the debt ceiling as a “fiscal issue,” the Fed Chair warned that even with their magnificent money printing machine, they could not protect the economy if the United States stopped paying its bills.

Things are moving in the right direction:

• Cumulative lags
• Economic developments
• Fiscal developments
• Committed

Busted!

Jay Powell had a chance to address what he knew about the risk to the banking system from a meeting held on February 14^th.  Instead, he downplayed the report, underscoring the risk to the banking system.

Key highlights included:

• Financial Risks Are Growing for Many Banks
• A Growing Number Report Unrealized Losses that Threaten Capital At the third-quarter end, 722 banks reported unrealized losses exceeding 50% of capital.

When pressed on the fact the report highlighted risks to ‘banks,’ specifically Silicon Valley Bank (SVB), Powell demurred. This was very disappointing, but the Fed is trying to mitigate the fact that the San Francisco Fed blew it, and aggressive hikes have played a role in depositors dumping their accounts.

SVB Was Highlighted

The script was laid out, and the Fed did nothing.

Banks with large unrealized losses face significant safety and soundness risks. Securities have traditionally been used for liquidity purposes. Today, the level of unrealized losses is causing some banks to face tough choices.

• Liquidity concerns.
• Earnings and Capital concerns.
• Banks will face difficulty in liquidating securities without realizing losses.
• Holding securities with below-market yields while funding costs increase negatively impacts net interest margins.
• Banks may need to sacrifice earnings to maintain liquidity.

The Session

All eleven sectors were lower, led by Energy (XLE), which continued to implode. The slide in oil is a major development. It speaks to the potential global recession. 

Financials (XLF) were right behind, and things got worse after the closing bell.

Heat Map

There was nowhere to hide yesterday with the few green patches coming from company-specific news.

And the Band Played On

I didn’t elaborate, but many reached out when I said Powell’s comments could be a disaster for the banking sector.

Ignoring the role the Fed has played by hiking rates at a record pace and suggesting the scare can be continued with actions outlined by Vice Chair Barr was the equivalent of Nero playing the fiddle as Rome burned.

When asked about the banking system, the Fed chair reiterated that it is "strong and resilient.”

After the close, shares of PacWest Bancorp (PACW) plunged more than 58%. And several other regional banks were taking it on the chin as well. 

But, unfortunately, I guess these banks didn’t get the memo.

Portfolio Approach

There are no sector weighting changes in the model portfolio this morning. 

Today’s Session

Lots of economic data out this morning.

• Initial jobless claims 242,000 consensus 240,000
• Continuing clams 1,805,000 consensus 1,865,000
• Labor productivity -2.7% consensus -2.0%

Stock futures improved slightly upon release of the data, but the 6.3% jump in unit labor cost against consensus of 5.6% might have stopped major indices from flipping into the green.

CME Fed Watch modeling now sees the first rate cut happening in September.

We’re watching bond yields very closely.  Maybe they are down for the wrong reason, but the lower they move, the more attractive stocks – especially growth names.

Outside of the banking scare, there has been an enormously positive reaction to earnings this morning. 

This is a great sign.

Gapping up in reaction to earnings/guidance:

SHOP +17.2%, FROG +12.9%, SEDG +11%, LMND +10.7%, W +10.3%, PCOR +9.8%, LNTH +9.1%, SHAK +7.9%, UDMY +7.7%, QRVO +7.4%, RSI +6.6%, HUBS +6.5%, INFN +5.9%, BALL +5.8%, CPE +5.6% (also to acquire Core Delaware Basin assets and Exit Eagle Ford), DDOG +5.5%, CFLT +5.2%, PGRE +5%, BPMC +4.8%, HST +4.5%, CTSH +4.4% (also increases dividend), EQNR +4.3%, ZG +4.2%, TIXT +4.2%, OCSL +3.9%, MELI +3.8%, RACE +3.8%, NE +3.4%, CSGS +3.4%, APG +3.4%, OPK +3.3%, AMED +3.3% (also to be acquired by OPCH), NFE +3.3%, OLED +3.2% (also acquires Phosphorescent OLED Emitter IP assets of Merck), AUPH +3.2%, BRKR +3.2%, CODI +3%, QGEN +3%, VNT +3%, OWL +2.9%, KLIC +2.8%, PH +2.7%, VMEO +2.5%, CTVA +2.2%, NGVT +2.2%, NSTG +2.2%, NSTG +2.2%, DINO +2.1%, COMM +2.1%, DFH +2.1%, PLMR +2%, RGNX +2%, SRI +2%, SUM +2%, AEIS +2%, WRK +2%, CWEN +2%, PLTK +1.8%, RGLD +1.7%, RGLD +1.7%, HCC +1.6%, SHEL +1.6%, GOLF +1.6%, ACLS +1.5%, FOUR +1.4%, FATE +1.3%, ALL +1.3%, AG +1.3%, FUN +1.2%, MKSI +1.1%, AVT +1.1%, BUD +1.1%, TFX +1.1%, APA +1%, FLT +1%, SBH +1%

Source: Briefing.com

Comments

The Fed (and others) can suggest that the banking system is safe and sound all they want. The problem is that no one believes them anymore and I doubt the carnage in the regional’s stops anytime soon. They dropped the ball even before inflation was called "transitory". They let the Jeannie out-of- the-bottle and words alone can’t get it back in. In my humble opinion, the only way they can restore confidence around what they say. Is first to admit they screwed up and second, to clean house and replace those at the top (starting with the SF Fed), with individuals who know how to regulate and do their job. Your reference to Nero sums it up perfectly. Terry Dowler on 5/4/2023 8:46:47 AM

They won't be drawing a picture of Powell and the Fed sitting atop a shiny city playing the harp when they write the history books. They should put a picture of the "Towering Inferno" next to him with Steve McQueen saying "I told you so" M Travis on 5/4/2023 10:56:03 AM

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