We finally got the Fed meeting this week where they laid out the policy path for the next several months. The Fed raised 50bps at this meeting and will go the same at the next two meetings while their holdings of Treasuries and mortgage-backed securities are scheduled to decline beginning in June at an initial combined monthly pace of $47.5 billion and stepping up over the next three months to $95 billion. So, the double tightening begins in earnest in June and the market now has to wrestle with re-pricing risk assets in a tightening scenario which we have not seen since the post dot-com crash era. The big difference was that era was during an economic recovery from a 2Yr recession whereas in 2022 growth is stagnating as evidenced by a 1.4% contraction in GDP for Q1.
The Stock Markets
If we look at the chart of the S&P futures over the last two weeks there is a see-saw in the price action that was exacerbated by a post-Fed rally that was reversed the next day. The chart now has triple resistance at the top and a potential double bottom going into next week. Not a high confidence scenario at the close on Friday but that should be cleared up in the coming sessions.
If we zoom out to a larger time-frame there was a new low created this week for 2022 so that means the trend remains down until we see a reversal. I would like to see the Relative Strength Index (RSI) on this chart tag the oversold line to identify a bottom but that would likely mean a drop to the 38.2% FIB around $380.
If we look at the NASDAQ ETF (QQQ) for technology we can see these stocks are leading lower and are already through the 38.2% FIB with no change in momentum yet. Again, I would like to see the RSI tagged on the oversold line before gaining confidence in a bottom. A few of the large cap technology names (Apple, Tesla, Microsoft) have held up this index so if these generals fall then this index should accelerate to one of the lower FIBS.
The Bond Markets
The bond markets have also been generating losses this year as the Fed withdraws liquidity. The shape of the yield curve is showing signs of steepening which means longer tenors will keep rising as the Fed raises the front-end. The two-year looks to be the pivot as Fed funds should get to 1.75% by summertime and the 2Yr looks to have already priced in this rate change. However, as the Fed reduces the balance sheet there will be more pressure on the mortgage market and investors will likely want higher yields to compensate for elevated inflation for longer tenors.
It is easier to see how much yields have changed in the last three months in this next chart of the 10YR. This tenor started the year at 1.5% and closed on Friday at 3.15%.
The top of the chart is from 2018 which is the last time the Fed raised interest rates and reduced their bond holdings. At this rate we could push through 3.25% by next week.
The Credit Markets
The investment-grade credit markets are getting hammered this year as we can see in the chart below of the AGG ETF that tracks a market-weighted index that includes Treasuries, agencies, CMBS, ABS and investment-grade corporates. You can see that prices have fallen precipitously in 2022 and are trading at prices not seen since 2009.
Also, the high yield market is down double digits this year and looks to be a falling knife which highlights what happens when the Fed begins to implement hawkish policies.
Could this be the end to the bull market? Maybe, it is too soon to tell but the evidence is beginning to add-up in that column and the bond market typically leads the stock market at turns in the market. We also saw a failed rally in the S&P after the Fed meeting which signals heavy resistance at the 4300 level. This does simplify the technical picture as the S&P needs to hurdle over that level and re-test it before an all-clear can be declared on the stock market. We also know the indices made new lows for 2022 and we will have to see if that continues next week but the charts above should outline where the support levels are for a targeted low (maybe).
This last chart is for perspective. The size of equities has outpaced the growth of the economy for many years and in particular after the pandemic due to government spending and easy Fed monetary policy. These vertical moves always need mean reversion so perhaps that process is underway.
That is all for now and thank you for being a subscriber!
President – Kisco Capital