Demand Destruction

the fed

Momentum is Red. Markets remain under pressure after Quad Witching. Markets remain very choppy after a day of wild swings and traders taking profits off short-term moves downward. 

This morning, the markets received one of the biggest warnings about the impact of higher prices and economic challenges. Shares of FedEx Corporation (FDX) plunged more than 21.5% on Friday as investors panicked over its latest earnings report. FedEx withdrew its 2023 earnings forecast, and reported quarterly earnings that fell under analyst expectations. This was a crazy day for the stock. More than 30 million shares were traded ahead of the last 30 minutes of the day. 

The traditional daily volume is around 2 million shares. The earnings report tells us everything about the state of the economy. Higher prices, fewer packages, supply chain problems, and deep questions about what comes next as the Federal Reserve prepares its next interest rate hike. 

Isn’t This What the Fed Wants?

As I’ve noted before, the Federal Reserve is largely going it alone in the pursuit of lower inflation. The White House and Congress continue to provide financial stimulus (inflationary stimulus) in the form of green energy repetition and the pursuit of student loan forgiveness

The Fed’s policies – raising interest rates and selling assets from its balance sheet – are a blunt hammer to the markets… and economy. So far this year, the Fed has raised its Fed funds rate from 0% to 2.25%. On Wednesday, the markets expect that the Fed will move up another 75 basis points to 3.0%. Some people are betting that the Fed could move by 100 points. 

Now, that would be quite stunning. At 3%, rates would be in-line with rates before the massive 2008 rate cuts by the Fed. And any time during the 2018 hiking cycle that sank the bond and equity markets in the later months of the year. The general view is that the Fed must continue raising rates now to offset high wage growth and tamp down inflation. But the market has now priced in a move to 4.25% by February 2023. That means we have 200 basis points to go higher. This could be a very slippery slope for the economy…

What has captured my interest is the much larger bets on the second half of the year. People are putting money on the Fed funds rate hitting 5%. That would be stunning (but possible) depending on movements on the inflationary side. It almost feels so bearish that it can be bullish. If we see more moves down in this market and much higher rate expectations later in 2023, I may start looking for some cheap companies by that point… largely on the back of what I believe is coming. Problems in the credit markets…

What Will the Fed Do?

The Federal Reserve has assured markets that it will be trimming its $8.5 trillion balance sheet at a record pace this month. The central bank targeted an uptick in selling bonds at a pace from $47.5 billion to $95 billion per month. However, the Fed hasn’t really kept its initial pace since it started tightening. 

We’ve seen numbers that project the Fed could reduce its balance sheet by $2 trillion by the end of 2023. This might be impossible. The U.S. Treasury debt market is worth about $24 trillion… and the Fed damn-near cornered it over the last 14 years. If the Fed does kick its balance sheet reduction to the next level, there could be a problem. 

As markets continue to struggle – and the Bond market sits in its first bear position in a generation – liquidity is falling. I was reading a note from Ralph Axel, a bond strategist at Bank of America. He warned we’d have a problem if the Fed’s management of the Treasury market turns sour. He noted that “declining liquidity and resiliency of the Treasury market arguably poses one of the greatest threats to global financial stability today, potentially worse than the housing bubble of 2004-2007.”

Plummeting Liquidity

One of the problems with liquidity dropping is the possibility of wider spreads. This can drive up borrowing costs at the consumer, business, and Federal level. Then, there’s the obvious component of this. Housing is a critical component of GDP expansion and contraction – along with cyclical spending. With the Fed planning to sell many mortgage-backed securities, rates could move higher on homes – even without the higher rate hikes. 

We could face a drop in home prices – exacerbating consumer debt challenges. If the credit markets freeze up – the Fed will have to pivot. It’s very hard to bet on the conditions that would set this off, but it’s clearly entering the terminology of Wall Street analysts… and even mainstream media outlets like CNN Business. 

With momentum negative, I urge a lot of caution. This is a very difficult economy and stock market to navigate. It’s best to be on the right side of cash, liquid-cash assets, and other strategies to benefit from any short-term selloff or worsening crisis.

Garrett Baldwin
Garrett Baldwin
Garrett Baldwin joined Godesburg Financial Publishing as Chief U.S. Markets Analyst in early 2021. A Johns Hopkins-trained Economist, he’s worked with hedge funds, venture capital firms, angel investors, and economic advisors to the U.S. government. Baldwin specializes in market anomalies and alternative investments. He’s written extensively on momentum, value, insider buying, and other unique strategies that provide investors that elusive edge.
Garrett Baldwin
Garrett Baldwin
Garrett Baldwin joined Godesburg Financial Publishing as Chief U.S. Markets Analyst in early 2021. A Johns Hopkins-trained Economist, he’s worked with hedge funds, venture capital firms, angel investors, and economic advisors to the U.S. government. Baldwin specializes in market anomalies and alternative investments. He’s written extensively on momentum, value, insider buying, and other unique strategies that provide investors that elusive edge.

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