In just over 8 minutes, Chair Powell's speech at Jackson Hole erased $78 billion from the wealthiest Americans net worth and $1.25 trillion from US equities markets.
The day started off with some optimism after a cooler than expected PCE reading, but Powell's speech reversed that ephemeral optimism, and then some.
The S&P 500 fell 3.38% and the NASDAQ 100 fell 4.10%
ARKK, (everyone's favorite speculative vehicle that began to resemble the Titanic in early 2021) fell 6.42%
Long bonds were bid, with TLT up 0.75%, but junk was sold off, with HYG falling 1.65%
There was no appetite for risk as high beta large caps were sold aggressively while low volatility stocks remained under less pressure. Defensive sectors showed rotational flows, such as utilities, staples, and healthcare, while growth, tech, meme stocks, and other rate sensitive risk were sold aggressively.
The overall market saw significant negative breadth, with about 5-to-26 advancers vs decliners on the NYSE for much of the day.
The speech was concise, and aggressively hawkish. The Fed chair gave no room for misinterpreting his intent, and there was no Q&A with reporters. The speech was delivered, and he departed. Having completed his job of cleaning up the mess left by the ambiguity of the July FOMC press conference.
Here are some key highlights, with bold text for emphasis:
Chair Powell: "Of course, inflation has just about everyone's attention right now, which highlights a particular risk today: The longer the current bout of high inflation continues, the greater the chance that expectations of higher inflation will become entrenched.
Powell emphasized inflation repeatedly, mentioning it a total of 46 times during his speech.
That brings me to the third lesson, which is that we must keep at it until the job is done. History shows that the employment costs of bringing down inflation are likely to increase with delay, as high inflation becomes more entrenched in wage and price setting.
This line struck me as the Fed Chair's attempt to very clearly say that there will be no pivot imminently.
The successful Volcker disinflation in the early 1980s followed multiple failed attempts to lower inflation over the previous 15 years.
A lengthy period of very restrictive monetary policy was ultimately needed to stem the high inflation and start the process of getting inflation down to the low and stable levels that were the norm until the spring of last year. Our aim is to avoid that outcome by acting with resolve now."
Finally, Powell discusses the need to be "acting with resolve now," which further emphasized that there is no near-term change in policy or softening of the Fed's stance on what their primary goal is with restrictive monetary policy.
After Powell spoke Fed Funds Futures went from a coin toss for a 75 bps hike at the next meeting, to favoring it with 61% odds.
We also saw Fed Funds Futures pricing in a terminal rate of about 4% to hit in the first quarter of 2023, and sustain itself for some time.
Probabilities previously favored a 3.75% terminal rate to be reached later this year, with the potential for the first cut in the first half of 2023.
Quantitative tightening is set to accelerate to a run rate of $95 billion per month as of this coming Thursday, as September begins.
This accelerated quantitative tightening process will be occurring with the Fed allowing up to $60 billion a month of treasuries to mature alongside selling up to $35 billion per month of mortgage backed securities.
The Fed is able to roll off about 43% of their balance sheet by simply not buying at US Treasury auctions as an indirect bidder. They don't have to sell a single Treasury security to accomplish this. They will instead mature and no longer be on the Fed's balance sheet as a result.
With the Treasury increasing their issuance by 2.5 fold during Q3 of 2022 to $444 billion, and likely a similar size for Q4, the lack of the Fed's indirect bid at auctions could not come at a less opportune time. Especially as China and Japan have been net sellers for the first half of 2022, adding pressure to the bond rout that was one of the worst in history.
This all means that in all likelihood rates may be rising, or at least staying put at relatively high levels compared to where we've been for the post-COVID crash era.
While the entire market is likely due for a haircut, the leadership we saw in technology from the mid-June low, predicated on the notion of a pivot, is fragile here. Financial conditions had eased, rates had dropped across a variety of credit markets, and as a result longer duration risk assets, like tech and growth stocks rallied hard.
We can see in the chart above that QQQ rallied as TLT fell. A phenomenon that is often concluded with QQQ catching down to TLT. Now that we have a greater issuance of treasuries during a time when the Fed is accelerating QT, and making it clear that the mantra "don't fight the Fed" is back in full swing, it feels as though any other long duration risk assets are in jeopardy.
The Wall Street Journal called a 'new bull market' in the NASDAQ after it had run up 20% from its lows. But that move, based on passive flows, momentum traders, short covering, and increased retail participation (particularly in buying call premium on growth, tech, and short squeezing memes) was more than likely all on borrowed time.
For the prior 13-year bull market, tech, and particularly mega cap tech, was an outsize beneficiary. The period of emergency-level accommodation by the Fed and other central banks appears to be coming to a rather unceremious end.
Mega cap tech now makes up 45% of the NASDAQ and nearly 21% of the S&P 500. Meaning that if indeed this trend of depreciating value of these former darlings continues then it will have a significantly deleterious impact on the NASDAQ and S&P 500 due to the concentrated weighting. Rising rates and QT are both powerful catalysts for that reversal of fortune we're seeing.
Markets are clearly in a risk off mode, and the Fed's messaging can no longer be confused. There is no pivot coming imminently. Quite the opposite. We can reasonably expect monetary policy to continue tightening in the US, and in much of the world, as central banks struggle to tame inflation with the only tools that they have. Tools that require them to disproportionately subdue demand.
The only reliable way to subdue demand is to significantly slow, or even reverse, economic growth. Thus, with Powell's repeated mentions of pain, it seems he is suggesting that higher unemployment and a deeper recession are imminent, and even desired, as the Fed attempts to avoid prior policy mistakes of the central bank not being aggressive enough in the face of seemingly intractable inflation.
Therefore, it's reasonable to expect that a re-test of 2022's lows is in the cards, and probably even a lower low from there. Be careful out there, as we see the potential for volatility to increase markedly in the weeks and months ahead.