Fintwit and the MSM would have you believe that the recent rally in the S&P500 is a bear market rally. It is a decent bounce, not too dissimilar to a 'dead cat bounce', but one I think is backed up by some positive fundamentals.
After a few months of panic when COVID hit the world, the Fed stepped in along with the US Treasury and backed the economy with hard cash. We all know what happened after that.
Trying to talk about the recent rally without putting any praise on the Fed and their FOMC participants is hard, not because of what they do, but because the rest of the market sits and waits for them and their meetings. So for all intents and purposes, it looks like the rate decision is the reason behind the rising stock market.
As a forex trader, you may have noticed that the world of foreign exchange had died in terms of volatility and any breakouts were quickly reversed. Having a mean reverting strategy in your arsenal would have been a good idea this last week. As you can see from the US dollar index (above) the DXY broke lower on the Fed's 25bps rate hike last night.
This is the Fed's statement: Recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation has eased somewhat but remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures.
Russia's war against Ukraine is causing tremendous human and economic hardship. The war and related events areis contributing to upward pressure on inflation and are weighing onelevated global economic activityuncertainty. The Committee is highly attentive to inflation risks.
The Committee seeks to achieve maximum employment and
inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 4-1/42 to 4-1/23/4 percent. The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. In determining the paceextent of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in the Plans for Reducing the Size of the Federal Reserve's Balance Sheet that were issued in May.its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.
In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals. The Committee's assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments.
Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michael S. Barr; Michelle W.
Bowman; Lael Brainard; James Bullard; Susan M. Collins; Lisa D. Cook; Esther L. GeorgeAustan D. Goolsbee; Patrick Harker; Philip N. Jefferson; Loretta J. MesterNeel Kashkari; Lorie K. Logan; and Christopher J. Waller.
They see inflation still being a problem for the foreseeable future and until they get full disinflation across the entire economy we should expect them to keep rates ~5% for longer.
The eurodollar yield curve dropped quite significantly and is still sounding the alarm that something is going to make the Fed pivot and that rates will at some point go into reverse. Or if not in reverse, a serious change in policy with another tool from their box of tricks. Any inversion is bad. The one above is just terrifying.
The SPX rose significantly last night into the close and that came on the back of the previous day's bullish close. The price action is testing the 50% line from the all-time highs down to the October 2022 lows. Some chartists would be looking for the inverse head & shoulders, others note that the price action is above the daily 200-period moving averages. Now, I know that at the end of January, a big Interest payment on US treasuries hit the market. This and a less 'Hawkish' Fed expectations may have been a good 1-2 combo in the last 30 mins of trading. Then yesterday was the 1st of February, and on the first day of the month, about $ 100 billion worth of spending hits the markets. If you knew that much money, effectively 3-4 times as much as the usual daily amount, was being pushed into the economy would you not also try and get in front of that flow?
I like to look at how many, as a %, of the companies that make up the S&P500 are trading above their 200-period SMA. As of last night that was nearly 75% of them. So there is strength in depth within the SPX, it's not just a few behemoths leading the way. Over 70% of companies that have reported this earnings season have reported beats on expectations, which shows some resilience and that inflation suits some companies.
The Nasdaq had not faired well as the inflation narrative grew stronger. Now we're seeing some positive moves higher. If we get a big drop in the PCE or CPI I am expecting the Nasdaq to rally hard.
So is this bullish move in the stock markets because speculators sense a pause or pivot by the Fed?
I personally do not think so. The chart above shows the levels of net spending by the US government. The big ticket items that they spend money on include Medicare, Medicaid, Defense, Veteran Affairs, Social Security, Education, and Interest payments on Treasuries.
The increased spending despite still relatively high taxation is supporting the economy and that bleeds into the stock markets.
The dip in the dark blue line above shows that the Treasury General Account has received more money over the course of January 2023 than it spent, which indicates that either they have received more taxes than usual or they have a limit on spending. I'd say it was the latter, as they haven't been able to drain the TGA by issuing more debt as the Federal Debt Ceiling has been reached. Discussions are currently ongoing to decide what to do about it, and last night Fed Chair Powell urged the politicians to raise the ceiling and kept in line with US Treasury Secretary Janet Yellen's remarks. Usually, the debt ceiling is increased, though it has been suspended in recent history, but to get any movement on this issue some political win for the opposition needs to happen. Currently, Congressman Chip Roy is trying to get the Biden administration to cut spending. If he gets his way that signals a sell recommendation!
Fiscal flows are relatively strong despite the Treasury's special measures. By the end of January 2023, they were higher than last year and even higher than in FY20/21. It hasn't been a good idea to sell into this type of strength.
The fiscal boost from the interest paid on treasuries (orange line) is helping to prop up the flows. The blue shows the rate in change of the Fed rate hikes. As we saw last night a rise of 25bps has now taken the interest rate up to 4.75% at the lower end of the bracket. The rate of change has dramatically decreased considering other central banks are still hiking by 50bps. US inflation is still around 6.5% and yield curves are very inverted. The longer interest rates stay around 5% the more Interest Payments will be made. Add that to an increasing Social Security payment and we could be in for a good year. As long as the politics don't mess things up.
The FOMC would like to see wage inflation reverse and the latest ECI report shows that both the Private and Public sector wage growth has slowed from their peaks. Still a way to go before you get wage increase reversals though. Companies have been shedding people rather than offering those same people a job for less money.
The market is anticipating the inflation story moving away and now they look forward to the next risk or reward. The Fed has dropped COVID as a risk from their statement, and the war in Ukraine is not affecting the US as much as Europe. There is a strong likelihood that the debt ceiling is raised, and then Treasury will issue more debt, and there will be more spending. Which will translate into higher stock market prices.
But keep your eyes and ears out for whatever Chip Roy and the @freedomcaucus do. They could ruin this party!
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