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Kevin Warsh certainly began his new term as Federal Reserve Chair with a bang. As I noted to a reporter yesterday, “any new CEO worth his salt – and he is the CEO of a huge institution – is going to want to do things his way.” He certainly made that clear during yesterday’s press conference. Markets seemed relatively sanguine ahead of the FOMC meeting. That changed in a hurry as the afternoon progressed.
Expectations for rate action at yesterday’s meeting were essentially nil, but there was no shortage of potential surprises. We wrote on Tuesday about a key question that investors needed to ask themselves:
First and foremost, is he a hawk or a dove? During his previous tenure at the Fed, Warsh was known as a hawk, especially when he pushed back against some of the monetary stimulus that was implemented in response to the Global Financial Crisis. Yet he was nominated for the Chair by a President who has vocally pushed for interest rate cuts throughout his second term, so it is difficult to imagine that Warsh was able to obtain the nod without portraying at least some predilection for lower rates.
Well, we certainly learned the proper avian analogy. It was clearly the raptor.
The relatively sparse FOMC Statement set the initial tone. Chair Warsh indicated that he wanted to reassess the amount of guidance that the FOMC offers, and that was the first sign of his reluctance to offer as much as his predecessors. Entire sentences and even paragraphs about assessing incoming data and its implications were omitted. (Here is a strikethrough comparison.) So too was a paragraph about how the individual members voted, though that was superfluous after a unanimous decision. (By the way, customers of IBKR Prediction Markets got that one largely correct. We noted on Tuesday that there was a 70% “Yes” for zero dissents.)
Once Warsh took the podium it became evident that his tone was very different from the reassuring “Goldilocks in a Suit” tone that Jerome Powell mastered and investors enjoyed. With rare exceptions, traders could grasp something hopeful in his commentary, allowing traders to choose their preferred adventure. Warsh was offering none of that. Yet some of the items were generally thought-provoking, such as the announcements about five task forces focusing on reforming the following areas: communication, balance sheet, data sources, jobs in an evolving economy, and inflation frameworks.
Short-term rates bore the brunt of the market reaction. On Tuesday, Fed Funds futures were pricing in a 50% chance for a hike by October, with the first hike fully priced in for March. By yesterday afternoon, an October hike was fully priced in. (IBKR Forecast Trader customers are far less certain, with a 67% “No” for rates at least 3.75% by October.)
That change in expectations was reflected in 2-year yields, which rose by 13 basis points. Yet 10-year yields only rose by 5 basis points, implying that traders were taking the new Chair at his word that quelling longer-term inflation was a serious concern. That led to the flattest yield curve in over a year. Today, with 2-years bouncing back by 2 basis points and 10-years recouping yesterday’s move, that spread is down to 28 basis points.
One of our investing mantras is that if markets have difficulty pricing low-volatility assets, like 2-year notes, how are they supposed to price riskier assets like stocks? Traders had great difficulty doing so yesterday afternoon.
Today, however, is another matter. Never underestimate stock traders’ willingness to step into any breach in tech stocks’ upward momentum. There was some positivity that arose from the signing of the memorandum of understanding with Iran, even though plenty of positivity had already been wrung out of that deal (see Monday’s “Buy the Rumor, Buy the (Sort of) News”). The news about Apple (AAPL) buying Intel (INTC) chips – at the behest of INTC’s 10% government investor – led to a 6.5% rally in the Philadelphia Semiconductor Index (SOX) that pushed that measure past Monday’s record high. That index was relatively unscathed yesterday, as it bounced 1.4% after falling 5.7% on Tuesday. And as the semis go, so does the entire tech sector. The Nasdaq 100 (NDX) is up more than 2% today after losing 1% yesterday, and that has led to 1% rally in the S&P 500 (SPX) that has nearly recouped yesterday’s 1.2% fall. No good dip remains unbought for long.