Skippy and a Different Jump

Articles From: Interactive Brokers
Website: Interactive Brokers

By:

Chief Strategist

Interactive Brokers

After writing yesterday’s piece, titled “The FOMC Cha-Cha: Skip, Hike, Pause, Pivot”, a song that was buried deep in the recesses of my brain emerged.  It was the theme to “Skippy, the Bush Kangaroo”, a children’s show from decades ago that I don’t recall watching very much – if at all.  But as the makers of the relatively contemporaneous “Schoolhouse Rock!” understood, children of that era (or any) were especially good at remembering catchy tunes they heard on TV.  Clearly, I was no exception.

I decided that Skippy would be an apt mascot for the Federal Reserve right now.  We noted yesterday that at least two influential FOMC members utilized the term “skip” during speeches this week, causing Fed Funds futures to price in lower odds of a hike at the upcoming meeting.  Today’s payrolls numbers reinforced that theme. 

Nonfarm Payrolls were another blowout, rising by 339K in May – well above the 195K consensus – and April was revised up by 41K to 294K.  However, Average Hourly Earnings rose by an as expected 0.3%, with a -0.1% revision to last month’s 0.5% report.  Also, the Unemployment Rate rose to 3.7%, above both the consensus view of 3.5% and last month’s 3.4%.  I’ll leave it to the economists to fully explain the contradictions inherent in the two reports that emerge from different data sets, but the bottom line was that traders could reasonably assume that a skip was in the cards.

Interestingly, odds for both a hike at the next meeting and July rose this morning.  We noted here yesterday and in the Financial Times today that Fed Funds futures were pricing in about a ¼ chance of a hike in June and a 2/3 chance of a hike by late July.  Those probabilities have risen to 35% for June and 90% for July now.  If yesterday’s rally was about hopes that the FOMC would be less likely to raise rates, either this month or next, today’s rally is either misguided or about something else entirely.  The latter seems more likely. 

Contrary to the last few days and weeks, the NASDAQ 100 Index (NDX) is currently a relative laggard, up “only” 0.8%, versus a 1.35% jump for the S&P 500 (SPX), and well behind the Russell 2000’s (RTY) 2.5% leap.  The recent narrow leadership is taking a relative back seat to a broadening rally featuring smaller and more economically sensitive stocks.  It is not perfectly apparent why today’s report would be the catalyst for sudden enthusiasm for that group of stocks, but it is a welcome sign for many investors when the divergence between outperforming and underperforming sectors is diminished by a rotation into the laggards rather than a selloff in the leaders.

Maybe we can attribute the recent resilience of the equity markets in the face of rising rates and quantitative tightening (QT) to the fact that monetary policy operates with a lag.  But I will assert that the most recent leg of the rally was caused by an asymmetry in the lags.  Restrictive monetary policies take several months to work its way through the system.  But monetary accommodation is like a shot of adrenaline, working its way into the financial bloodstream in a matter of weeks.

We all know that the Fed has been assiduous with QT, steadily reducing its securities holdings over the past two years, as the graph below shows:

securities held on the Federal Reserve Balance Sheet

Source: Federal Reserve H.4.1 reports, Interactive Brokers

But the response to March’s banking crises provided a temporary jolt to the monetary system.  The Fed extended about $300bn in loans to various banks which show up as assets on the Fed’s balance sheet.  That undid a substantial amount of the recent QT.  The graph below shows how the two have diverged recently:

federal reserve balance sheet total assets (top), securities holdings (bottom)

Source: Federal Reserve H.4.1 reports, Interactive Brokers

The good news, which has been reflected in rising stock prices, is that the jump in the Fed balance sheet clearly made its way into the markets.  Unfortunately, that effect should be waning – unless, ironically, there is another round of banking woes.  The balance sheet is not quite back to its levels of early March, but it is getting there.

So, there we have it.  A skip is continuing to bolster stocks after a jump gave them fresh monetary ammunition. 

Oh, and in case you think my fondness for kangaroos is a passing fad, look carefully over my shoulder when I do televised appearances from my home.  There is always a small vintage Qantas advertisement featuring a stylized marsupial.  I should have been ahead of the curve when it came to skipping and hopping.

3 thoughts on “Skippy and a Different Jump”

    1. Thank you for the compliment, Amit! We hope you’ll continue to follow our Traders’ Insight articles.

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