Good morning contrarians!
This briefing is normally entirely forward-looking, focusing on economic and corporate events that can move markets in the day ahead. However, in light of yesterday’s rather bizarre activity it’s worth unpacking this a little bit.
The Fed Set-Up
Markets were on a bit of a knife’s edge over yesterday’s meeting of the Federal Open Market Committee. Federal Reserve officials had expressed concerns over (no longer transitory) inflation and were making noise about speeding up the Fed’s unwinding of bond purchases. The prospect of this so-called tapering acceleration was by all accounts a looming presence. The possibility of it actually happening was still seen as a bit remote considering how long it had taken the Fed to implement tapering in the first place.
Our assessment was that markets would rally only if the Fed said it would stick to its pace of tapering. We went as far as to anticipate a sell-off if tapering was accelerated. This was not particularly outlandish in light of what markets had been signaling in the days and weeks leading up to the announcement.
The Fed’s decision then to not only speed up tapering, but do so at an aggressive rate. The pace of tapering will double this month and then accelerate further next year. Fed officials signaled as many as three rate hikes in 2022, two more in 2023 and 2024.
The Market Reaction
The market reacted to this hawkish Fed tilt by moving higher, which appears to fly in the face of tried and true market dynamics. Hawkish central bank surprises = selling. That’s just the equation.
There are two ways to explain what happened:
Investors were expecting an even more hawkish tilt by the Fed. Perhaps even a rate hike. So this was a relief rally in light of that specter.
Investors were not fearing a hawkish Fed at all, but were instead more concerned the central bank was failing to take inflation seriously.
It looks like maybe item 2 is the better explanation. Inflation is bad for everybody and that bleeds into markets. An accommodative Fed is great, but not if the drumbeat of inflation is banging as loudly as it has. So basically the market is rewarding the Fed for getting this right.
Won’t a tightening cycle upend the bull market? Yeah, eventually. But for now apparently inflation was the bigger concern.
This Morning’s Movement
Stock futures are continuing their rally as of 0620. Small caps are seeing the biggest gains, with the Russell 2000 up 1.3%. The Nasdaq is pointing to gains of 0.8% at the open. Dow Industrials and S&P 500 are 0.7% higher.
Bonds are rallying a bit as well. The yield on the 2-year is down to 0.64% after peaking over 0.7% yesterday. Ten-year yields are down to 1.44% from 1.47%.
Commodity prices are also rising. WTI crude is up about 1.4% to trade around $72/barrel. Natural gas is up 3%. Palladium is up 7%. Copper 3%. Other industrial metals are up as well. Cryptos are a bit higher with bitcoin trading hands around $49,000.
Housing Data
Today we receive a couple of key indicators for the health of the U.S. housing market. At 0830, the Census Bureau announces new home building permits and housing starts for November. The building permits are particularly forward-looking as these grant construction of new homes. As you hopefully know by now (because I bring it up every single time we get real estate data), homes are the biggest of big ticket items that individuals are likely to purchase in their lives. Building permits is therefore a key gauge of demand for new homes, and the front end of it. This makes it a vital figure for the health of the U.S consumer, which as we know drives the world economy.
Economists expect 1.66 million new permits, corresponding to a gain of 0.5% over last month. This number has been in healthy territory for awhile after peaking in February. Housing starts are what come right after building permits. This is when construction companies break ground on new homes. Economists expect this number to come in at 1.58 million, up about 3% over what was reported last month. Here too the figure is in very healthy territory.
Once interest rates move higher it can be expected to take a pretty serious bite out of both figures. But we aren’t there yet. Of course, even without higher interest rates there could be a slowdown in demand. We saw that in the early days of Covid.
We also have initial jobless claims today, seeing how it’s Thursday. Expectations are for about 200,000 new claims, up from 184,000 last week. That’s out at 0830.
A little later in the morning at 0915 we get industrial production and Markit PMIs. The Services part of the PMI is the most interesting, seeing how this is the bulk of the U.S. economy. Expectations are for a 58.5 print, about the same as last month and still well ahead of the 50 level that separate expansion from contraction.
Finally, you’ll be sure to hear about interest rate decisions from the European Central Bank and the Bank of England today. These are really only interesting for currency traders. The BoE is actually imminent, at 0700. The ECB reports at 0745.
Also earnings: Adobe (ADBE) is due to report before the open at 0930. After the close at 1600 we will hear from Rivian (RIVN) and FedEx (FDX).
This all makes for a busy morning. Hope you’re ready.
The Bottom Line
The risk on mood looks likely to continue, with all morning metrics pointing to healthy risk appetite. The one outlier is bonds, which usually sell off when there is risk on. But that shows waning investor concern for inflation, which is a good thing.
Defiant Stock Market Rallies in Face of Hawkish Fed