In case you chose to embark upon a digital detox or overindulged on green beer yesterday, markets were fixated on the Federal Reserve. The Fed’s Open Market Committee (FOMC) issued a statement at the end of a two-day meeting, which preceded a press conference by Chairman Powell. Traders widely expected meaningful consequences in the aftermath of the meeting, and they were correct on that front. Yesterday, we wrote about what traders should be expecting to hear from the FOMC and the Chair. As I write this, shortly after the US markets open, let’s see whether the Fed meeting delivered what we expected.

Connect the dots

In the early days of astrophotography, the astronomer Clyde Tombaugh compared photos of the night sky and noticed that one of the dots moved. That was how he discovered the planet Pluto (yes, I know that the astronomical equivalent of Moody’s later downgraded it to non-investment grade planetary status). I mention that story because it was a similar activity for those of us who wanted to see if any members of the FOMC changed their assumptions about the pace of potential Fed Funds rate changes. Compare the two-dot plots below. The one above is yesterday’s, the one below is the prior dot plot from December. If you look very closely, there are a few dots in 2022 and 2023 that moved higher, but those moves were insufficient to raise the median estimates for rates in those periods. The dot plot showed that there is a broad consensus of the FOMC that rates will stay low for about 2 years or more.

(Click on image to enlarge)

Source for both charts: Bloomberg

SLR

The FOMC’s statement omitted any mention of a change to the Supplemental Leverage Ratio, and Mr. Powell explicitly punted away a question about it at the press conference, saying that any announcement about SLR will come at a later date. (He even let that reporter ask another question.)Yet the Fed quietly decided to raise the daily counterparty cap on overnight repurchase agreements from $30 billion to $80 billion. Interestingly, that facility is barely used at its current levels. That move was taken by some bond analysts as a signal that the Fed was preparing for dislocations that might result from a phase-out of the SLR rules. We wrote yesterday: “If the Fed extends the SLR change, it could lead to a sharp, snapback rally in bond prices. If not, bond yields could continue to rise unless the Fed makes a sufficient commitment to fight inflation to offset the SLR concerns.”We will discuss the inflation outlook at greater length in the subsequent point, but I believe that the SLR silence amidst the repo change is a key factor in 10-year Treasury note yields rising 10 basis points to around 1.75% this morning.

Inflation and Full Employment

I give Mr. Powell a lot of credit here. It gets really tedious to be asked the same questions over and over again. There are only so many ways to answer repeated questions without getting testy. After repeated assertions to Congress that the Fed remained committed to keeping an accommodative monetary policy until or unless we see some combination of full employment and sustained inflation above 2%, the Chairman faced a similar inquisition from the Fed’s press corps. Through it all, he once again calmly reiterated that he would not only tolerate, but in fact welcome a modest amount of inflation and that he remained committed to not raising rates pre-emptively. The stock market initially liked that answer – equity markets are quite dependent upon easy money – but after some reflection, bond markets decided otherwise. Stock traders, at least in the early going, have resumed following their fixed income compadres.

The First Move is Often the Wrong Move

I’ve been doing this a long time – too long, some will argue – and over time traders develop some heuristics that work for them. I shared one of my most trusted adages yesterday: “Be cautious about jumping into a knee-jerk reaction based upon a few headlines at 2 pm”.My reasoning here is simple. Traders (especially algorithmic traders) who react to headlines are not equipped to truly understand all the nuances that are encompassed in a Fed statement and subsequent conference call. We saw bonds rally slightly yesterday afternoon, and that is now attributed more to short covering by aggressive traders rather than true capital allocation. The bond market tells a very different story now than it did yesterday afternoon. Stocks, especially tech shares that comprise the bulk of weighting of the Nasdaq 100 Index (NDX) and a significant minority of the weight of the S&P 500 (SPX), have been somewhat slavishly following 10-year yields. When bonds reversed, so did those indices, giving back the gains that were achieved yesterday afternoon. 

Circle April 28^th on your calendars. That is the date of the next FOMC decision. As more of us get vaccinated and the economy proceeds towards normality, the next meeting should be at least as consequential as yesterday’s.