Straight from the Trading Floor

By Michael Reinking, Sr.

This week has really been about consolidation. After rallying over 5% last week, US markets spent the week alternating between gains and losses. However, a late day rally today pushed the S&P 500 up 1.8% for the week, while the Dow and Russell 2k both ended either side of unchanged.

I know I’m starting to sound like a broken record, but this type of action is pretty impressive considering oil prices have rallied >10% this week and global yields continue to surge.

The latter has occurred as Fed officials have gotten more embolden in their calls for multiple half point rate increases this year. Last week the market digested the DOT plot and Chair Powell’s press conference with no negative reaction, and it feels like the central bank has taken the opportunity to signal that 50bps is coming in May and possibly June as well.

Just today, Citi was out calling for not one, not two, but four straight 50bp rate increases.

Today alone, yields across the curve were up between 10 – 18bps and are up over 30bps for the week, with the exception of the 30yr which was only up 18bps.

The volatility in Treasury markets jumped this week with the ICE BofA MOVE index surging to ~125 from ~92 last week (still below the 140 level hit earlier this month).

The curve continues to flatten and there are inversions occurring all over the place 3-7yrs vs. the 10yr, 5yr vs. 30yr and the 2yr vs. 10yr that everyone seems to watch for signs of a recession hit new lows ~15bps.

I am by no means an expert on reading the tea leaves of the yield curve, but Fed Chair Powell chimed in on how the Fed is thinking about this in his speech at NABE earlier this week. He pointed to a research paper written in 2018 titled, (Don’t Fear) The Yield Curve (apparently Eric Engstrom and Steven Sharpe are Blue Oyster Cult fans).

By the way, this was published around the last time these types of inversions were occurring and the Fed tried to tighten policy.

Using this as a guide the 18-month forward minus the 3m T Bill spread has been steepening very sharply (as has the 3m vs. 10yr) which is emboldening the Fed’s view that there is not a recession on the horizon.

The economic data this week seems to confirm that view though we are definitely starting to see some cracks in the housing market.

This week’s claims data hit the lowest level since Bryan Adams was buying guitars at the local five and dime, way back in the summer of ’69. The more positive surprise came in the newly branded S&P Global Flash PMIs (formerly Markit).

This is one of the first pieces of economic data to be released post the Ukraine invasion and both Eurozone/US readings exceeded expectations . There was a deceleration of activity in Europe, but not as bad as feared. The biggest impact was seen in the pricing components which hit new record highs.

The U.S. data was actually very positive showing an acceleration of activity for the month.

The line that really caught my eye was, “Firms also noted that less severe supply chain disruptions and job creation allowed firms to step up production.”

That is an important development and if it is not derailed by the situations in Ukraine/China could mark an important inflection point in goods inflation.

Clearly the rise in yields impacts mortgage rates the Mortgage Bankers Association showed that applications fell 8% this week and new/pending home sales both missed expectations. This is occurring just ahead of the spring selling season and is adding to affordability concerns.

Housing related stocks were some of the worst performing this week with the S&P Homebuilders ETF down ~9% this week, -24% YTD.

Elsewhere within equity markets Energy, Materials and Utilities outperformed all up >3%. The latter is somewhat interesting as the sector does not typically perform well in a rising rate/inflationary environment.

This week Utilities and Financials both joined Energy as the only S&P sectors higher YTD up ~1%. But that is a distant second place to energy which is up ~42% YTD and the spread to the mega-cap tech heavy sectors, which are down ~10% YTD, is now over 50%.

The only sector that didn’t end the week higher was healthcare which was off <1%. There was a clear outperformance by large cap this week as the ICE 50 Index was up 2.5% while the ICE Small-Mid 2500 Index was flat for the week.

If you were scoring this week, the bulls definitely won and have their first real winning streak this year. While the volatility in Treasury markets was surging the VIX has continued to move lower and as we pointed out last week this forces the “systematic” sellers that were blowing positions out as the VIX moved >30, back into the market.

One thing is for sure this rally is being met with a ton of skepticism and for the time being is flying in the face of the mantra which has worked for the last decade “Don’t Fight the Fed”.