In the Crosshairs


The Fed moved 75bps on Wednesday and put the stock and bond markets in the crosshairs as prices plummeted into the close on Friday. The kill-shot for the markets came in the form of projecting 4% Fed funds rate by the end of this year (according to their dot-plot) and that took the markets by surprise.

As you can see in the chart below of the S&P 500 Futures (includes overnight trading), the market has reacted negatively to the Powell speech in Jackson hole, the CPI release and now the Fed meeting on Wednesday. In all three cases there has been a sharp reaction as the Fed continues to emphasize their “resolve” in maintaining a hawkish policy stance.

Bond Prices Keep Falling

The Fed is now reducing their balance sheet by $95B monthly to work off a balance that doubled during the pandemic to $8Trillion (a crazy amount). This divestiture combined with raising the Fed Funds rate is causing a re-set to asset prices. You can see the rate of change in 10Yr Treasury yields to the right. This is one of the fastest increases on record and is causing big losses in a relatively short period of time.

Higher interest rates CAN be tolerated but when the rate of change is this fast, consumers and companies have difficulty adjusting. For example, some debt is floating rate and companies that did not hedge their rate exposure this year will suffer earnings impairments as there is no time to adjust to soaring interest rate expenses. Consumers will bear the higher cost of higher monthly payments for credit cards, mortgages and automobile loans. Both will impair spending and in turn growth in the economy so a recession is looming.

Don’t Forget the Currencies

Not to mention that overseas earnings from the international companies will now be subject to currency losses. We saw a dramatic move in currencies on Friday after the Euro dropped 1.54% and the British Pound fell 3.59%. For reference, a 0.5% move in a day is typically considered significant as currencies normally move slowly.

In the chart below you can see an example of the EURO vs the US Dollar which has been in a downtrend since the high in 2008. However, the EURO topped in January at the same time as the S&P 500 and now is trading below parity which means a trip to Europe continues to cheapen.

The Bigger Picture – Return to Sender

As rates move higher it becomes harder to make outsized earnings for companies as new challenges appear that never existed under the period of quantitative easing (QE) that began in 2008 and ended in 2022. Currency differentials, interest costs, tight labor, inflation and supply chain issues add up to a recessionary environment that should last into 2023.

If we look at the chart of the S&P 500 from the pandemic low, the decline from the January high looks like a return to sender (pandemic low) is underway. We came close on Friday to breaking the June low so unless a massive double bottom is going to happen next week I think the S&P will eventually get to the bottom of this chart.

In either case, the market is now left to its own devices until earnings season next month and the momentum is now to the downside.

Economic Dirt

Many central banks moved after the Fed this week so it is not a surprise that stocks and bonds are dramatically re-pricing. I have all of the central bank actions that happened this week below as the other economic data this week is a footnote now:

  • Federal Reserve Bank of the United States (Fed) – The Fed went 75bps as expected and Powell emphasized in his presser that they have a strong labor market which gives him license to tighten policy to stem inflation (my words). Their dot plot of the fed funds rate (a survey from each voting member) went from 3.4% to 4.4% by year end which implies another 125 bps of hikes over the next two meetings (NOV & DEC).
  • Bank of England (BOE) – The BOE raised for the seventh consecutive time to 2.25% from 1.75% but held off from quickening the pace of its rate increases as governmental actions to cap soaring energy bills could ease inflation. Among the nine members of the BOE’s monetary policy committee, five voted for the half-point rate increase, three voted for a larger three-quarter point increase and one other voted for an increase of a quarter point.
  • Bank of Japan (BOJ) – The BOJ went unchanged as expected and the Yen sold off in reaction but for the first time since 1998, the Finance Ministry intervened and bought yen to defend the depreciation of the Japanese currency. The Finance Ministry said they “will take necessary steps against any excessive moves in the Forex market.” Historically, these currency interventions are not effective, so this looks like a desperation move as the Yen keeps depreciating as they hold rates near 0%.
  • The Swiss National Bank raised 75 bps as expected.
  • The Riksbank (Sweden) went 100 bps and 75 bps was expected.
  • The Norges Bank (Norway) raised 50 bps as expected.
  • The Bank of Indonesia raised 50 bps while 25 bps was expected.
  • The Central Bank of Taiwan increased 12.5 bps as expected.
  • The Hong Kong Monetary Authority raised 75 bps to match the Fed.
  • The BSP in the Philippines went +50 bps as expected.
  • The Vietnamese Central Bank raised 100 bps which was NOT expected.
  • The Turkish Central Bank cut rates by 100 bps to 12% even as inflation is running at 80% but Turkey is under dictatorship and the move was a direct order from the President.
Paul McCarthy, President of Kisco Capital, LLC

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Paul J McCarthy III

President, Kisco Capital

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.