Goldilocks or Kobe Bryant?

I’m sure that many of you are wondering why a late basketball superstar is mentioned in the title of today’s piece.  Kobe Bryant was regarded as having one of the best pump fake moves in basketball history.  The market’s immediate reaction to Chairman Powell’s press conference was exuberant, with 3% jumps in major US indices in the final 90 minutes of the day.  As I write this, about 90 minutes into the following session, we have given back all those gains and then some.  Can you blame me for thinking about classic pump fakes at a time like this?

Note the significant round trip in just 3 hours of normal market hours (and notice that we’re still up for the week):

4 Day Chart NASDAQ 100 Index (NDX, red/green 1 minute bars), S&P 500 Index (SPX, blue line)

Source: Interactive Brokers

It appeared for a while that Mr. Powell was inhabiting his classic role as “Goldilocks in a Suit,” assuaging the worst fears that investors held after weeks of jawboning by various Fed Governors.  The FOMC raised its target rate by 50 basis points, as expected, and outlined its plans for reducing the size of its balance sheet beginning in June.  The Fed’s plans for balance sheet reduction were somewhat vague before yesterday, and bond investors seemed pleased with the news that the Fed will allow a maximum of $47.5 billion in maturing bonds to run off its balance sheet for three months starting in June and doubling that amount to $95 billion per month from September on.  At that pace, the balance sheet would shrink by about $1 trillion per year.  Considering that the balance sheet more than doubled from about $4.5 trillion before March 2020 to just under $9 trillion now, that would still leave a significant amount of financial accommodation in place for several years.  Bond traders, who are usually more clear-eyed than their equity counterparts, relished that news.  Two-year note yields fell by 14 basis points from a multi-year high of 2.784%, and 10-year yields fell by about 4 basis points.  It turns out that bond traders bit on the pump fake too.  Today the 2-year yield has recouped about half yesterday’s drop, while the 10-year yield is currently 15 basis points higher at a multi-year high of 3.08%)

As is often the case, traders fixated on one line in the commentary – Mr. Powell’s comment that a 75-basis point hike was not “actively considered”.  We noted yesterday that Fed Funds futures were implying just under a 50% chance of a 75-basis point rise at the next FOMC meeting.  After an evening to consider that comment, many investors realized that a 12.5 basis point reduction in the implied Fed Funds rate for the coming six weeks[i] was hardly worth the enthusiastic response.  For starters, Mr. Powell kept the possibility of bigger hikes on the table, they’re simply not under active consideration.  Alternatively, many investors took the relatively dovish tone of the press conference as a sign that the Fed’s inflation-fighting resolve may not be sufficient.  The rising yields at the long end of the curve send that message, which equities are now hearing.

Ahead of yesterday’s meeting, we asserted that there was a reasonable likelihood for a relief rally in the three-day period ending.  That seemed prescient yesterday, less so now.  Much will depend upon the market’s reaction to tomorrow morning’s Nonfarm Payrolls and Unemployment reports.  As of now, our January call to “Sell the Rips” remains firmly in place.  Yesterday’s move seemed overdone and due for a fade, but today’s moves are more than routine profit taking – this is a potentially vicious selloff.

Earlier in January, after Congressional testimony that soothed some frayed nerves that investors were displaying while indices pulled back from a year-end rally, I questioned whether Chairman Powell was “Goldilocks in a Suit or Sully Sullenberger”.  Even at the time we questioned whether the Fed Chair was as skilled a pilot as the market believed him to be, writing:

“Here’s the problem with that analogy: we have no idea if Mr. Powell will be able to land the market without incident this time around.”

Today, after a Kobe-worthy pump fake and ongoing volatility, we’ll extend the pilot analogy one step further – please make sure your belts are securely fastened, because the fasten seat belt sign remains lit.

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[i] A 50% chance of an incremental 0.25% hike is an expected value of 12.5 basis points.  (0.5 * 0.25% = 0.125%; a basis point is 1/100 of a percent)