Powell Hints 4 Hikes – I Say 3 – Here’s Why
By David Nelson, CFA
In a stunning comeback after more than a year of hibernation volatility returned to markets as February ended a 10 month winning streak reminding investors stocks don’t move in just one direction.
There’s a lot of data we can point to as the catalyst but #1 with a bullet has to be inflation or at least the perception it is on the horizon. It’s important to point out the correction started with a hot jobs report at the beginning of the month showing wages were rising faster than thought. It’s always fascinating as an observer of market behavior that something we’ve been hoping to happen for nearly a decade would suddenly cause investors to panic once it arrived.
In today’s computer driven trading environment the correction took less than 10 trading days to unfold and even less to recover more than half the losses. Look, bulls aren’t going to feel comfortable until we’ve taken out the highs and some time passes to put the episode behind us. The technical damage is real and unlikely repaired in just a couple of weeks.
In the end stocks follow earnings and cash flow. Currently estimate revisions are on I-95 North and sales for the first time in years are accelerating. The expansion of CAPEX is just starting
In the meantime there are any number of obstacles for the market including a Fed Chairman that isn’t afraid to talk down markets when he feels they are getting ahead of themselves. All eyes this week were on new Fed Chair Jerome Powell as he marched to the hill for his inaugural testimony before the House Financial Services and Senate Banking Committees Tuesday and Thursday respectively.
One look at this picture tells me the Fed is just blowing smoke
With most reports pointing to just 3 rate hikes for the year investors added to positions Monday in a strong showing for U.S. equities. The prepared testimony by Mr. Powell got a standing ovation as stocks opened Tuesday again in the plus column but gave up the gains ending down hard on the day as the new Fed Chair hinted a fourth was in the cards. Saying he sees “strengthening in the economy” since December was followed by a round of selling as good news once again morphed into bad news.
One look at the yield curve tells me this isn’t a likely event unless there’s a dramatic change on the long end of the spectrum. I say 3 hikes is a possibility but 4 is just smoke unless the Fed is willing to risk an inverted curve often a precursor to recession. Last thing the economy needs is a self-fulfilling prophecy with economists all chiming in on the danger of an inverted curve.
Six months ago the 30 year yield was 2.73% and today sits at 3.14% or a spread of 41 basis points. A year ago the 3 year was at 1.44% and today now up to 2.44% or a spread of a 100 basis points or 1%. In other words it’s pretty obvious the short end of the curve is rising much faster than the long end.
The Fed isn’t blind to this dynamic and I suspect later in the year the rhetoric will morph into something a little less aggressive fearing market participants will start extrapolating a worst case scenario.
With the second estimate for the Q4 GDP coming in at just 2.5% revised down from 2.6% the economy isn’t as hot as we’d like to see. There’s room to let up on the brake and still remain on a healthy path to normalization. Probability for a hike in March sits at 100% and likely baked in by market participants. The language of the release and projections from some of the Fed Governors should give us a little more insight on the road ahead.