The Bond Market Suggests a Shift in Fed Policy
March has provided investors with an especially news-rich environment that raised an already high level of uncertainty over the economy’s future. Conflicting economic data, questionable banking practices, and heightened speculation over the Fed’s next move left equity investors sitting on their hands while bond market participants got busy pricing in some significant changes to their economic outlook.
This month’s release of economic data points to a continued decline in Headline and Core CPI as well as Wholesale prices (“PPI”). All point to the Fed’s successful return of the economy to below-trend growth. The missing piece to their puzzle has been how to reconcile strong employment with that objective. The latest employment data reflects the build in layoff announcements as unemployment ticked up from 3.4% to 3.6%. Not much, but it’s a start. Throw into the mix a moderation of Retail Sales from January’s big jump, an erosion of Industrial activity and forward-looking surveys, and continued weak oil prices and you can venture a guess where lagging inflation data will go.
The question for many now is whether the Fed, with an assist from a few mismanaged banks, has accomplished, hopefully not overly so, its mission. The bond market has weighed in on that and responded in the affirmative. Bonds rallied dramatically and the 2-10 treasury spread narrowed by half in the days that followed the Silicon Valley Bank takeover by the FDIC. A lower terminal rate for Fed Funds was priced in and speculation rose over the Fed hitting the Pause button on rate hikes at the May meeting. Equity investors, on the other hand, stirred their portfolios with little conviction. The boundaries of the current trading range weren’t challenged, leaving a mild recession priced in from the December ’21 highs.
Last week, the FOMC responded with another 25bp rate increase, leaving Fed Funds at 5%. Many analysts believe a Pause by the Fed would be prudent. The thought being that it would provide a window for lagging data to catch up with reality and time for any after-effects of the banking kerfuffle (not crisis) to permeate through the economy. The current Earnings Season is drawing to a close without significant negative effect as many had feared. 68% of the 498 S&P 500 companies reported earnings above analysts’ expectations. That compares to a long-term average of 66%. That result falls into the “not bad” category and hints of a rolling recession scenario rather than a broad-based decline into negative GDP Growth.
April 12-13 marks the next release of inflation data to be digested and debated prior to the Fed’s May 1-2 meeting. If the Fed remains data-dependent and gives any weight to the events in the banking sector, a case could be made for a Pause in policy action. Stay tuned.
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