Hunting Season

Macro Markets

FOMC

It has been a very eventful four days. We have had regional banks fail and “bailed out”, we have had complete chaos across other banks and financial systems with rising rates to blame for some part. When the Federal Reserve starts to raise interest rates, it generally keeps doing so until something breaks, or so goes the collective Wall Street wisdom.

Now that we have achieved the second and third biggest bank fails just over the past few days we have had a break in the system and a potential reason for the Fed to pause possibly. The situation could force Fed Chair Jerome Powell and his colleagues into choosing what problem demands the central bank’s top focus. Is it inflation which seems to be trending down from goods inflation to wage inflation while holding labor intact or the failure of the American second-tier banking system?

The Fed, with other regulators, rolled out measures over the weekend including a backstop for bank deposits to shore up confidence in the banking system after the collapse of the Silicon Valley Bank on Friday.

Fed officials slowed their pace of rate rises last month when they boosted the benchmark federal funds rate by a quarter point to a range between 4.5% and 4.75%. The move followed increases of a larger half point in December and 0.75 points in November and at three previous meetings.

Goldman Sachs no longer sees a case for the Federal Reserve to deliver a rate hike at its meeting next week, citing “recent stress” in the financial sector. The firm had previously expected the Federal Reserve to hike rates by 25 basis points. Goldman Sachs added that they still expect to see 25 basis point hikes in May, June and July, reiterating their terminal rate expectation of 5.25% to 5.5%.

The market is essentially at a 50/50 flip at the moment for a 25bp hike or no hike. We personally believe if we see a full-fledged fix of the banking sector before March 22nd FOMC we will get a 25 bp hike or we’ll get a slowdown and no hike, but the rest of the hikes stay put. The wage inflation and CPI reports could warrant a pause in hikes for this month.

CPI

We once again have printed another CPI print lower than the previous month's report. Inflation continues to fall as the previous 6.4% increase was succeeded by a 6.0% increase in the seasonally adjusted year-over-year release. This trend continues to be bullish, as it indicates that the measures being put in place by the Federal Reserve are working. Moving forward, one of the bigger issues is how much can the Fed continue to raise rates to curb inflation, given that many bigger regional banks are starting to see signs of contagion. The downfall of SVB was one of the breaking points that forced the Fed’s hand not to raise the rate hikes any further than 25 bps, as it stands from a probability standpoint. It’s hard to tell at this very moment if enough has been done to eliminate the remaining bits of inflation to reach the target of 2.0%.

One of the biggest contributors to the CPI print was shelter, which took up over 70% of the reading for this month, with less food and energy. As noted in the report, “The index for rent rose 0.8 percent in February, while[…]the index for lodging away from home increased 2.3 percent in February.” Disregarding food and energy, this metric was by far the stickiest of the inflationary measures. As reported in a previous newsletter, housing continues to struggle due to the lack of supply and unprecedented levels of low inventory. As the supply continues to fall, the competition to be in homes, furnish homes, and rent apartments, will continue to stay elevated.

Other important measures that increased from the previous month were food and energy indexes, per usual. Energy saw an increase of 5.2% yoy and energy increased by 9.5% yoy.

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Unemployment and Changing Markets

One of the key indicators of a recession is a rising unemployment rate. Many people have wanted to see these indicators rise, as it would indicate a slowing of market demand and less of a need for the Fed to increase rate hikes. However, as many have noticed, unemployment has not gone up, but rather has been going down a bit. Shown below is the chart of jobless claims reported every month. Though the numbers have consistently been under the consensus for the month, recently we have seen this number go up above expectations. The unemployment rate has also been very low and is around 3.4%.

One of the major reasons this is occurring is the large number of retirements during the surging savings in 2020. The civilian labor force participation rate trend has declined since the 2008 financial collapse. However, 2020 saw one of the most dramatic falling participation rates in the workforce. It has taken three years, and the participation still needs to be back up to the pre-pandemic levels. That creates a big bottleneck in most supply chains and businesses as they constantly look for work despite increasing wage inflation.

Participation is not the only variable contributing to the stuck unemployment rate. When the 10/2-year treasury yields become inverted, unemployment typically takes quite some time to rise. We can see that the figure below shows the delay in the unemployment rate after the first month of the inversion curve. Currently, the markets are entering their 10^th month of a yield inversion, right around when we see an increase in the unemployment rate. At first, there is a slight decline in the unemployment rate followed by an increase, like what has been playing out since 2022. Since unemployment is a lagging indicator of struggling market conditions, delaying the industrial market for unemployment makes sense.

On average, there are about 6 months between the peaks of the equity markets and a rising unemployment rate. Fred data shows that the during this time of rising unemployment, enough time has passed for equities to find their bottom and begin recovering again. Also, every time the unemployment rate peaks, the bottom of the equity market is experienced. So, why is this last year looking a little different than these other recessions? Since we are dealing with inflation, the Fed had to increase rates, and the markets started to suffer. At the same time, we were experiencing a shortage of workers, which is a mix for a disaster, as it becomes very difficult to manage which direction to move the economy. Does the Fed raise rates and hurt businesses for a long time to help inflation, or do businesses continue to search for workers, raising wages and keeping growth in the country while keeping inflation high?