Control Panel: Signal or noise?

As your humble METAR weather reporter, I only post a Control Panel once a week to try to sort signal (trend) from noise.

The stock and bond markets do not have a clear signal at this time. Both markets are swayed from day - to- day by traders’ feelings about the direction of the Federal Reserve.

The Fear and Greed Index is in Greed. Stock traders are champing at the bit and pushing stocks higher even though the Fed has warned continually and the Cyclically Adjusted P/E Ratio (CAPE Ratio) is still as high as Black Tuesday , 1929.

Bond traders began to believe the Fed a couple of weeks ago after several weeks of unfounded optimism. The Treasury yield curve is beginning to rise. It is still inverted and will become more so as the Fed raises the fed funds rate.

The USD, which has been falling since October 2022, may have bottomed as it is beginning to rise.

The Chicago Fed’s National Financial Conditions Index (NFCI) provides a comprehensive weekly update on U.S. financial conditions in money markets, debt and equity markets, and the traditional and “shadow” banking systems. The NFCI is dropping, showing that broad financial conditions are loosening. This is contrary to the Fed’s program of slowing inflation by cooling the overall economy.

The latest statistics for January 2023 are: Consumer Price Index (CPI): +0.5% ; Unemployment Rate: 3.4% ; Payroll Employment: +517,000. This is hotter than the Fed wants to see.

There is no question that the Fed will raise the fed funds rate at their next meeting. But the fed funds is an overnight rate. The NFCI shows that tightening the fed funds didn’t cause the broader market rates to tighten. In fact, they are loosening, including junk bond yields.

The Fed is executing its slow, steady QT by allowing $60 billion per month of Treasury securities and $35 billion per month of agency debt and agency mortgage-backed securities to roll off its balance sheet. It could increase this to directly impact longer-term bond yields but it probably won’t since that would upset the markets. The Committee will manage securities holdings as needed to maintain ample reserves over time and will never allow their assets to go to zero.

Since the current Fed assets are $8.3 Trillion, the rolloff of $95 billion per month represents slightly over 1% per month. This is gggrrrraaadddduuuaaallll by plan.

I think that the stock and bond market upswings since the start of 2023 are noise, not signal. There is no question that the fed funds rate will rise to at least 5% and probably higher. The fed funds rate is not a powerful tool against inflation that is caused by fiscal stimulus (such as a rise in Social Security) or against long-term interest rates.

The METAR for next week is cloudy. The markets are at the whim of traders whose animal spirits are still running high but who are facing headwinds from the Fed.