A couple weeks ago in More Rate Hikes?, I observed
“The S&P is knocking on a widely watched glass ceiling around 4200. If it convincingly breaks through, traders will take it as an all-clear and run with it.”
This has come to pass. There remain a number of crosscurrents. The yield curve remains steeply inverted, although as we’ve also observed before, it becomes a more timely indicator when it begins to uninvert. The Fed is making noises about a potential pause or “skip” in rate hikes, a possible scenario being stepping back to 25 bp every other meeting, effectively halving the pace of increases. Prior step downs in this cycle have led to stock market rallies. Market breadth has been exceptionally skinny, as observed in Anorexia Nervosa, but is binging on fast food today, as the Dow Jones 30 and the Russell 2000 both leave the NASDAQ 100 in the dust and the rally reverberates around the world.
In the very short term, seasonality is bullish. As Norm Fosback described in his 1975 classic Stock Market Logic, price increases tend to be concentrated in the first few trading days of each month. This may be due in part to many monthly paydays falling at the beginning of the month. On an even shorter time frame, Fridays have a bullish bias as traders don’t like to be short over the weekend. Regardless of origin, however, the decisive penetration of S&P 4200 is short term bullish, sending it rapidly hurdling towards the next century mark. Although there is no rational basis to believe this number has any magical significance, it has been widely cited in the financial media and has served as a ceiling for the S&P for several weeks. That this breakout might be taken by traders as a “buy” signal isn’t much of a stretch.
Looking out further, the picture is less clear. The case for a “June swoon” also incorporates seasonality … why else would you want to Sell in May? Markets are overbought on AI giddiness and the resolution of the debt ceiling. Another widely cited factor is a giant sucking sound of liquidity as Treasury rebuilds its cash cushion with issuance potentially approaching the trillion dollar mark. On the other hand, investors in the aggregate finding themselves with an increased Treasury allocation may try to rebalance by buying stocks. As discussed in How Monetary Policy Affects Asset Prices, this phenomenon can only “work” through rising stock market cap.
All things considered, it could be several weeks before we see another meaningful selloff in stock prices.
i wonder if the tga refill will mostly draw from the rrp facility- currently over 2 trillion, and thus not produce the extra tightening being attributed to it.
I don’t know; there could be an indirect link. In the bigger picture I do think it’s being overestimated. It’s a widely publicized issue and presumably widely priced in. And it doesn’t represent a new or unanticipated source of Treasury security supply, merely a transfer of issuance from prior to the lifting of the debt ceiling to after. So whatever liquidity effect it would have would be the reverse of what was seen in the weeks leading up to the budget agreement. It’s far from assured it would overwhelm other crosscurrents both foreseen and unforeseen.
Commentators commonly cite increased short end (TBill) borrowing. This would presumably pressure TBill prices lower and yields higher, but short rates are where the Fed’s rate targeting efforts are most concentrated. So there might be a net shift of MMF assets from RRPs to USTs. And MMFs are hot hot hot at these rates. But irrespective of the exact mechanism, you could see Fed policy as at least somewhat offsetting. And as Hussman might say, in the bigger picture it’s a swap of one government obligation for another. For every dollar of liquidity in Federal Reserve Notes withdrawn, an equal volume of US Treasury Bills is added.
I continue to suspect a less widely talked about source of liquidity is at least as important; the payment of interest on bank reserves. In contrast to most of history, the Fed is actually paying money into existence. I have yet to find an authoritative answer on whether this is fully reflected in the Fed’s balance sheet. Bernanke is quoted as having referred to it as a “deferred asset” – to eventually be reflected in reduced remittances from the Fed to Treasury – but for now it appears to be money creation, which might actually help explain why the Fed’s rate hikes are having an underwhelming effect. Any insight you have on this is welcome.
Re market breadth … even after this (potentially transient) surge in the broader market, IWM (the Russell 2000) and VXUS (the world ex-US) are both still only in the neighborhood of their 2018-2019 highs. As you’ve observed, it’s still a very narrow market with the S&P levitated by just a handful of giants.
Even VT (the entire world stock market) is over 11% in just the Big Seven.
warren mosler on why higher rates CAUSE inflation
https://www.youtube.com/watch?v=MEax1ngTWZw
Thanks JK. I didn’t watch the whole thing (why don’t people write any more!), but thought I heard Mosler affirm the GMO point connecting government deficits with corporate profits:
The Curious Incident of the Elevated Profit Margins
And empirically, rate hikes seem to have lost whatever potency they may have had last year. Hussman has also drawn a sharp distinction between how the Volcker hikes crushed inflation and the current hiking cycle … under Volcker, rising rates were the result of cutting the money supply, whereas it’s now assumed that rates themselves are the prime mover. I still don’t know exactly whether or how interest on excess reserves is reflected in the Fed’s balance sheet reporting, but there’s no doubt that paying out interest at increasing rates is an altogether different animal than having them rise as a consequence of scarcer money.
Mosler’s suggestion that cutting rates will reduce inflation by cutting government deficits however is nuts. We’ve just been through a decade and a half of some of the lowest rates in history and have the highest deficits in history. Rate cuts “work” by making borrowing cheaper and incentivizing more of it. It’s no mere coincidence that the current borrowing binge started early last decade not long after ZIRP was institutionalized and grew from there.
So the problem is if higher rates don’t cure inflation and lower rates don’t either, what’s the Fed to do? Hussman would say abandon its “deranged” monetary policy and get back to focusing on money supply … and Volcker no doubt would agree.
Regardless, it remains clear that the first sign of renewed progress would be a decline in asset prices … they led consumer inflation lower last year and rising asset prices preceded the stalling out of that progress this year.
mosler writes plenty
https://warrenmosler.com/publications/
re your comment: “So the problem is if higher rates don’t cure inflation and lower rates don’t either, what’s the Fed to do? ”
.
really the issues are fiscal. in order to reduce inflation the fed can’t do anything but raise rates enough to crash the economy, raise unemployment, and thus lower demand. their problem is that the inflation is at least as much on main street as on wall street. rates impact the latter immediately, but main street is harder to affect.
.
just heard kuppy mention that snowmobile sales hit a record last year – doesn’t sound like a recession.
Thanks again. So Mosler is an MMT guy? FWIW I have no beef with Modern Monetary Theory. It’s MMP – modern monetary practice – that needs a rethink…
It’s hard to see how a still higher FF rate target would do much besides create distortions. And they might be severe enough to “crash the economy” and even kill inflation. But it’s not necessary to crash the economy to kill inflation, just take asset prices down another leg. We managed to do that last year and bring down inflation without crashing the economy … the only misfire is now evident in resurgent asset prices.
No question though there’s a big fiscal component. In theory higher rates would discourage borrowing by making it more expensive, and since (at least until the advent of interest on reserves) money is created by being lent into existence, reduced borrowing results in reduced money supply.
But Washington has been a price-insensitive borrower, at least in the short run. It took a couple years for the post-GFC ultralow rate regime to spur big deficit increases, and it could take a couple years for higher rates to spur restraint. And it’s not just the government sector – a lot of corporate debt is planned in advance, has longer maturities and turns over slowly enough that it takes a while to respond to rate changes too. Hence phrases like “long and variable lags”.
Asset prices react much more quickly though. Stock, bond and commodity prices began rocketing higher practically from the instant the Fed slashed rates to zero and fired up the printing presses in March 2020. Consumer prices took much longer to take flight. When the Fed started tightening in 2022 asset prices again responded instantaneously, while consumer price inflation continued to accelerate. Asset prices stopped their descent later that year though, and consumer price inflation responded over a period of months, declining at a declining rate, until progress stopped as of the last release.
Now as asset prices continue to rise, does consumer price inflation again respond with a lag? The striking feature here is that when this rate hiking cycle began, almost anyone would have considered a 5%+ FFR enough to crash the economy. Yet here we are, employment still a seller’s market, housing by and large in a seller’s market, and stocks in a rip-snorting bull market.
And the yield curve has been in an epic inversion for nearly a year. I’m starting to wonder if this setup echoes 2006. Recall in that year the yield curve also inverted … but it wasn’t until 2008 that the bottom fell out.
Follow up on your observation about TBill issuance drawing on RRP assets … looks like I came close. I just ran across a MarketWatch article on this point. It affirms our suspicion that the liquidity drain is overblown and that the TBill issuance will indeed mostly displace abundant RRP balances. Some could also come from bank excess reserves.
limiting supply-side inflation with price controls:
.
https://www.newyorker.com/news/persons-of-interest/what-if-were-thinking-about-inflation-all-wrong
Weber would have fit right in the Nixon, Ford or Carter admins. The main qualification … ability to find inflation bogeymen everywhere but right out in plain sight.
Duh.