The Market: Prepping for Jay & Janet
Look for a hawkish Jay Powell to catalyze the next leg down in SPX.
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Discussion
In last weekend’s market update I outlined the following path into the critical May 1 “Jay and Janet” policy show:
With the QRA and May FOMC both coming on May 1, the set-up is in place for a market-positive one-two dovish punch from Yellen and Powell. But not from current SPX levels.
The Fed was decisively hawkish in the lead-up to its blackout period, leaving financial markets incredibly vulnerable to a wide open window of weakness from now until May 1. I suspect that with SPX -10% off its 5265 ATH circa 4739 by May 1, Powell very likely will present the FOMC message in his standard dovish manner; and if Yellen uses the QRA to unleash her TGA liquidity bazooka, equities will go vertical.
But first things first:
SPY bounce to $514 by Wednesday in order to reset oversold tactical indicators, followed by a
-8% decline to $472 by May 1
I updated the path a few days later to account for MSFT’s key earnings report on Thursday, projecting that MSFT’s ER would be a downside catalyst for SPX.
Per usual, the market chose to take its own path:
The market certainly bounced, but only to a high of $509.75 on SPY, not the $514 I thought last weekend.
Instead of MSFT taking down the market Thursday night, as I wrote on Tuesday, it was META’s ER Wednesday night that catalyzed a sharp drop in Thursday trading. MSFT’s ER was reasonably well-received, albeit with the help of a post-META pullback and attendant IV expansion ahead of the report.
There are still two trading days ahead of the critical May 1 “Jay and Janet” event, so SPX could pullback ahead of May 1, but it won’t get down to the $472 level posited last weekend.
So, where does this leave us with May 1 fast approaching?
The Week Ahead
FED communication this week made it clear inflation data and political pressure have lowered the strike price of the Fed Put. With SPX off its local lows, credit spreads off their local highs, and volatility pricing back on the floor (all pending Monday/Tuesday price action, of course), the set-up is NOT in place for Chair Powell to drive markets higher via his May 1 press conference. If anything, the set-up is for a move in the other direction.
Janet Yellen is a wildcard. She showed up Thursday for an interview, presumably in response to financial market volatility, and I could make the case that her mere presence acted as a put, given the market recovery; however, the substance of her commentary, combined with the fact USD/JPY saw no intervention Friday despite a sharp decline, was not dovish, and if anything was hawkish. In short, I don’t have a great feel for how she is going to use the May 1 QRA. The market rally Friday may have had nothing to do with Yellen, but rather “Kenny G” (as my market buddy affectionately refers to Ken Griffin) and his eerie control over short-term market movements via the options market.
From a market structure perspective, this market continues to track the April 2022 path with precision: SPY peaked Friday at $509.88 (closed at $508.26) versus a closing 20dma of $509.93; VVIX has collapsed; IG CDX has pulled back; sentiment has reset; and dovish hope abounds for rate cuts to commence in September, despite FED communication and Fed Funds futures pricing strongly suggesting otherwise. Unless the Fed and/or Treasury (aka Jay and/or Janet) decides to halt this term premium-driven correction in asset prices via dovish May 1 policy implementation, the April 2022 analog suggest a sharp continuation of the SPX pullback will commence in anticipation of hawkish May 1 policy Monday/Tuesday and continue/or in the wake of a hawkish Powell press conference Wednesday afternoon.
With equities off their lows and VOL and credit spreads off their highs, IMO SPX is priced for neutral May 1 policy. If Jay & Janet both come out dovish, ala last November, obviously SPX will return to its 5265 ATH in a matter of days, if not hours. But that’s highly unlikely given the inflation backdrop. I think the best the market is going to get is what it’s priced for: a neutral Jay & Janet, where they seek to implement policy that keeps rates elevated but wrap it in a soothing “don’t worry, a soft landing is still likely” message. But the best case is not my base case.
My base case for May 1 is neutral Janet, hawkish Jay. With UST 10s and 30s closing Friday at 466 and 478 - within 30-40 bps of their highs last October - rates are not high enough to warrant a dovish QRA pivot, nor are they low enough to warrant a hawkish shift up in coupon issuance. Janet could project dovish use of her TGA liquidity bazooka, but it’s likely too soon for that given hot growth and inflation mean Jay & Janet need to slow the economy here soon in order to set the stage for a recovery in economic conditions and asset prices into Election Day. The three prior term premium-driven corrections in asset prices and attendant economic decelerations each lasted exactly three months: April-June 2022, August-October 2022, and August-October 2023. The Fed’s June 12 SEP is likely to formally project no cuts in 2024, with an outside chance of another hike starting later this year. June 12 is a convenient date to catalyze the market’s descent into a final low circa June 30 and SPX 4500. This brings us to the Hawkish Jay discussion…
Hawkish Jay
Back on April 16 Chair Powell specifically cited the fact that 3- and 6-month Core PCE inflation readings are above the 12-month rate. Yes, he appeared to dovishly wrap the fact inflation is reaccelerating with the call for the Fed to simply hold Fed Funds at current levels for as long as necessary to bring inflation down; but subsequent hints from FRB New York Williams and FRB Atlanta Bostic about the potential for more hikes, as well as communication from Nick Timiraos (see here, here, and here) strongly suggests Powell is not as dovish as he appears. And this is confirmed by market sentiment looking for cuts to start in September versus a Fed Funds futures market priced for just 12 bps of cuts by the December FOMC.
Over the course of 2022 the Fed Funds futures market routinely led a hawkish Powell, and that’s exactly the set-up heading into May 1.
It is not a coincidence the April 2022 market path continues to play out here. Look for Powell “follow” FOMC members into “hinting” at the possibility of no cuts in 2024 and perhaps even restarting rate hikes later this year.
The Bottom Line
Jay & Janet have a window here to tighten financial conditions and slow the economy and real-time inflation readings, before pivoting to a more dovish stance sometime in July in order to engineer a recovery in asset prices and economic activity into Election Day.
Look for them to seize the opportunity on May 1.