A Whiff of Hawkishness?

Yun Li and Tanaya Macheel of CNBC report the Dow falls more than 500 points to close out its worst week since October:

Stocks fell on Friday, with the Dow Jones Industrial Average posting its worst weekly loss since October, as traders worried the Federal Reserve could start raising rates sooner than expected.

The blue-chip average dropped 533.37 points, or 1.6%, to 33,290.08. The S&P 500 slid 1.3% to 4,166.45. Both the Dow and S&P 500 hit their session lows in the final minutes of trading and closed around those levels. The Nasdaq Composite closed 0.9% lower at 14,030.38. Economic comeback plays led the market losses.

For the week, the 30-stock Dow lost 3.5%. The S&P 500 and Nasdaq were down by 1.9% and 0.2%, respectively, week to date.

St. Louis Federal Reserve President Jim Bullard told CNBC’s “Squawk Box” on Friday it was natural for the Fed to tilt a little “hawkish” this week and that the first rate increase from the central bank would likely come in 2022. His comments came after the Fed on Wednesday added two rate hikes to its 2023 forecast and increased its inflation projection for the year, putting pressure on stock prices.

“The fear held by some investors is that if the Fed tightens policy sooner than expected to help cool inflationary pressures, this could weigh on future economic growth,” Truist Advisory Services chief market strategist Keith Lerner said in a note. To be sure, he added it would be premature to give up on the so-called value trade right now.

Pockets of the market most sensitive to the economic rebound led the sell-off this week. The S&P 500 energy sector and industrials dropped 5.2% and 3.8%, respectively, for the week. Financials and materials meanwhile, lost more than 6% each. These groups had been market leaders this year on the back of the economic reopening.

The decline in stocks came as the Fed’s actions caused a drastic flattening of the so-called Treasury yield curve. This means the yields of shorter-duration Treasurys — like the 2-year note — rose while longer-duration yields like the benchmark 10-year declined. The retreat in long-dated bond yields reflects less optimism toward economic growth, while the jump in short-end yields shows the expectations of the Fed raising rates.

This phenomenon hurt bank stocks particularly as their earnings could take a hit when the spread between short-term and long-term rates narrows. Bank of America and JPMorgan Chase shares on Friday lost more than 2% each. Citigroup fell by 1.8%, posting its 12th straight daily decline.

Fed Chairman Jerome Powell said Wednesday that officials have discussed tapering bond buying and would at some point begin slowing the asset purchases.

“This week’s first whiff of an eventual change in Fed policy was a reminder that emergency monetary conditions and the free-money era will ultimately end,” strategists at MRB Partners wrote in a note. “We expect a series of incremental retreats from the Fed’s benign inflation outlook in the coming months.”

Commodity prices were under pressure this week as China attempted to cool rising prices and as the U.S. dollar strengthens. Copper, gold and platinum fell once again on Friday.

Friday also coincided with the quarterly “quadruple witching” in which options and futures on indexes and equities expire. This event may have contributed to more volatile trading during the session. 

Jeff Cox of CNBC also reports Fed’s Jim Bullard sees first interest rate hike coming as soon as 2022:

St. Louis Federal Reserve President James Bullard told CNBC on Friday that he sees an initial interest rate increase happening in late-2022 as inflation picks up faster than previous forecasts had anticipated.

That estimate is even quicker than the outlook the broader Federal Open Market Committee released Wednesday that caused a hit to financial markets. The committee’s median outlook was for up to two hikes in 2023, after indicating in March that saw no increases on the horizon.

Bullard at several points described the Fed’s moves this week as “hawkish,” or in favor of tighter monetary policy than what has prevailed since the onset of the Covid-19 pandemic.

“We’re expecting a good year, a good reopening. But this is a bigger year than we were expecting, more inflation than we were expecting,” the central bank official said on “Squawk Box.” “I think it’s natural that we’ve tilted a little bit more hawkish here to contain inflationary pressures.”

The FOMC’s revised forecasts reflect that sentiment.

For 2021, the committee raised its expectations for core inflation as measured by the personal consumption expenditures price index to 3% from the March estimate of 2.2%. It also brought its median estimate for inflation including food and energy prices up to 3.4%, a full percentage point jump from the prior outlook.

Along with that, the committee hiked its outlook for GDP growth to 7% from 6.5%. As recently as December the committee had been looking for growth of just 4.2%.

“Overall, it’s very good news,” Bullard said of the economic trajectory during the reopening. “You love to have an economy growing as fast as this one, you love to have a labor market improving the way this one has improved.”

However, he cautioned that the growth is bringing faster-than-expected inflation, adding that “you could even see some upside risks” to price pressures that by some measures are running at their highest levels since the early 1980s.

That’s why he thinks it would be prudent to start raising interest rates as soon as next year. The Fed dropped its key overnight lending rate to near zero at the outset of the pandemic and has kept it there since.

Bullard said he sees inflation running at 3% this year and 2.5% in 2022 before drifting back down to the Fed’s 2% target.

“If that’s what you think is going to happen, then by the time you get to the end of 2022, you’d already have two years of two-and-a-half to 3% inflation,” he said. “To me, that would meet our new framework where we said we’re going to allow inflation to run above target for some time, and from there we could bring inflation down to 2% over the subsequent horizon.”

Bullard is not a voting member this year on the committee but will get a vote next year. Stock market futures briefly added to losses while the 10-year Treasury yield ticked higher as Bullard spoke.

The other dynamic of the Fed’s policy is its $120 billion minimum of asset purchases. Bullard said he thinks it will take several months of discussion before the central bank decides how to begin reducing that pace.

He also cautioned that with the economic dynamics uncertain ahead, that also will mean monetary policy will remain in flux.

“These are things far in the future in an environment where we’ve got a lot of volatility, so it’s not at all clear any of this will pan out the way anybody is talking about. So we’re going to have to go meeting by meeting to see what happens,” he said.

And Dan Burns of Reuters reports the Fed's Bullard looks to a bond-buying taper not on 'automatic pilot':

The coming reduction in the Federal Reserve's bond purchases may bear little resemblance to the "automatic pilot" tapering exercise the U.S. central bank conducted seven years ago, as officials grapple with volatile data - on inflation in particular - during the rebound from the COVID-19 pandemic, a Fed official said on Friday.

"In the 2013-2014 taper we went on automatic pilot and didn't do much," St. Louis Fed President James Bullard said in an interview on CNBC.

"This time around, I mean look at this data," he said. "Look at how outsized all these numbers are and how volatile everything has been. I think we're going to have to be more state-contigent than we have been in the past."

The Fed currently holds nearly $7.5 trillion of Treasuries and mortgage-backed securities (MBS) within its $8.1 trillion balance sheet and is adding to those holdings at a rate of $80 billion and $40 billion, respectively, each month as part of its extraordinary measures to support the economy during the pandemic.

At a two-day policy meeting this week, Fed officials opened a dialogue about when and how to slow - or taper - those purchases as the economy recovers and inflation runs above the central bank's 2% target. read more

Bullard, who also told CNBC that he was among seven Fed policymakers to predict a first rate hike in 2022 , is not only eyeing a less steady-as-it-goes approach to the taper this time around. He said he might favor also a more rapid reduction in MBS purchases in the face of a housing boom that could evolve into a "threatening housing bubble."

"I'm leaning a little bit toward the idea that maybe we don't need to be in mortgage-backed securities with a booming housing market and even a threatening housing bubble here, according to some people," he said, echoing concerns raised by some other Fed officials, such as Dallas Fed President Robert Kaplan. "So we don't want to get back in the housing bubble game. That caused us a lot of distress in the 2000s."

"Some people argue that there's not much difference between MBS and Treasuries anyway, so there's no reason to go one way or the other," Bullard said. "But I would be a little bit concerned about feeding into the housing froth that seems to be developing."


Bullard, who becomes a voting member of the policy-setting Federal Open Market Committee next year, predicted a "healthy debate" in coming meetings as officials devise and announce their plan. Should the taper play out as Bullard described, it would mark a notable departure from the Fed's script last time.

Then, after formally announcing its plan at its December 2013, meeting, the central bank cut its then-monthly purchases of $45 billion of Treasuries and $40 billion of MBS by $5 billion each at each ensuing meeting, wrapping up the wind-down by the end of October 2014. While it said the reductions were not on a pre-set course, it never once deviated from that path.

"In 2014, we really didn't have to exercise that option, but this is a situation where we might have to exercise the option," Bullard said. "You don't really know where inflation's going to go here, even the economy as a whole."

Moreover, the rest of the world's economies in 2022 are likely to follow the United States in their emergence from the global recession triggered by the coronavirus pandemic, "possibly booming the way the U.S. is today," he said.

"We'll see if all that develops. But I think we have to be ready to make adjustments as necessary as we go along this path."

Alright, it's been a busy week with the Federal Reserve wrapping up its 2-day meeting on Wednesday and the "Bullard bomb" this morning jolting stocks and other risk assets.

Keep in mind, James Bullard is a well-known dove. Two years ago, when President Trump discussed firing or demoting Jerome Powell, whom he picked to be Fed chair, Bullard who was one of the most dovish members of the US central bank, favored lowering interest rates by a quarter point and said that becoming Federal Reserve chairman is “something I’d love to do.”

So, when Bullard goes on CNBC to state “I think it’s natural that we’ve tilted a little bit more hawkish here to contain inflationary pressures,” it sends a clear message that many members on the FOMC are ready to start talking tapering and rate hikes.

Of course, Jay Powell gets the last word but even he's hinting about not talking about talking anymore:

The tapering conversation has begun.

One of the most unique phrases the Federal Reserve has ever used to communicate with markets has been retired. 

At least according to Federal Reserve Chair Jerome Powell.

Asked Wednesday during a press conference about whether the Fed discussed plans to begin slowing down its pace of asset purchases, Powell confirmed that at this week's policy meeting, the central bank began "talking about talking about" changing this program. 

"I expect we'll be able to say more about the timing [of tapering asset purchases] as we see more data," Powell said Wednesday. "There's not a lot more light I can shed on that. But you can think about this meeting as the talking about talking about meeting, if you like. And I now suggest that we retire that term, which has served its purpose well."

For months now, Powell and other Fed officials have reiterated that they both were not "talking about talking about" tapering asset purchases — which are still running at $120 billion per month, according to the Fed's statement on Wednesday — nor were they "thinking about thinking about" raising interest rates. But now that the talk about tapering asset purchases has begun, chatter about quantitative easing (QE) among the media and Wall Street Fed watchers can shift from words to deeds. 

The biggest market-moving development out of the Fed's announcement was a change in its "dot plot," outlining expectations for interest rates. That data series now suggest up to two rate hikes by the end of 2023 could be warranted. Previously, this plot had shown only one hike would likely be necessary in 2023. 

As Yahoo Finance's Brian Cheung notes, Powell sought to downplay the importance of this data in his press conference, saying — among other things — that the dot plot should be taken with a "big grain of salt." Powell's desire to move investor focus off of this single data point did little to sway markets that sold both stocks and bonds in response to this news. 

As for when the Fed's talk on tapering will turn into action, attention now turns to the Fed's annual economic symposium in Jackson Hole, set for late August. Gregory Daco at Oxford Economics said Wednesday that "consensus expectations" are that Powell will signal at that meeting a change in the Fed's asset purchase program may be warranted early next year.

Not surprisingly, markets didn't react well to all this "hawkish" talk.

The 2-year Treasury yield spiked and long-dated US Treasury yields fell on Friday and the yield curve continued to flatten as market participants bet that the Federal Reserve will act sooner to clamp down on inflation pressures if they persist.

In terms of stocks, cyclical shares -- Financials (XLF), Industrials (XLI), Energy (XLE) and Materials (XME) -- led the declines this week as did interest rate sensitive sectors like Utilities (XLU), Consumer Staples (XLP) and Real Estate (XLRE). Technology shares (XLK) were mostly flat for the week:

Discussing this week's action, Martin Roberge of Canaccord Genuity writes this in his latest market wrap-up, Mid-Cycle Confirmation:

Stocks are down a little more than 1% this week and the catalyst for the correction was the Federal Reserve now expecting to lift interest rates in 2023 rather than in 2024. We believe this subtle change in expectations along with the steep correction in industrial commodities and cyclical stocks confirm a growing view among investors that peak growth is here (more below) and the transition from early to mid-cycle dynamics has been completed. Against this backdrop, the US$ or DXY firmly jumped above its 200-dma while the CDN$ plunged >2%. Our hunch is that the Loonie should test its 200-dma also at 78.7. The decline in bond yields and commodity prices accelerated the rotation from value to growth stocks. As a result, the NASDAQ is flat for the week and either a triple top is here or a runaway breakout accentuating the pain trade is in the cards. We believe odds favour the latter considering the pending summer rally season. What comes after this seasonality could bring the real test for stocks.

This week we want to focus on the volatility in commodities. Is this the end of the cyclical bull market or just a pause to refresh? First, as we alluded to in our June 9 and June 16 incubators, peak conditions have likely arrived for economic growth, mfg. PMIs, EPS revisions, and profit margins. As we showed in these two wires, this backdrop often coincides with more volatility in risk assets. This week serves as a reminder. That said, as we highlighted in our May 19 incubator and again today with our Chart of the Week, after a strong start to the calendar year, a summer pause in commodities is the norm, not the exception. We think this is especially true this year since it has been the second strongest start for the GSCI commodity index since 1970. The second panel of our chart shows that both the overshoot to the historical average and the calendar point to a summer breather. Tack on the Chinese government crackdown on speculators, and we believe commodities seem like a lose-lose proposition in the near term. However, our chart also shows that the rally in commodities could resume later this summer. As we explained in prior notes and through our virtual roadshow, we believe an acceleration in the global re-stocking cycle should provide the demand underpinnings to fuel another cyclical rally in commodities until spring next year.

I have to hand it to Martin, he's sticking to his long commodities call which he had at the start of the year but he's also cognizant that a summer pause is likely in the cards.

On Monday, hedge fund legend Paul Tudor Jones appeared on CNBC stating if the Fed treated higher inflation with "nonchalance,"it's a green light for the inflation trade.

He was particularly bullish on commodities, stating this:

Well I’m going to watch the Fed on Wednesday. If they treat these numbers, which were material events, they’re very material, if they treat them with nonchalance, than I think it’s just a green light to bet heavily on every inflation trade. The idea that inflation is transitory to me is that that one just doesn’t work the way I see the world. So, I look at $88 trillion of assets that are managed by asset managers of that 670 billion are invested in commodity indices like Bloomberg Commodity Index, Goldman Sachs Commodity Index, that’s about three quarters of 1%. If I rewind just to 2011 when inflation was peaking at 3%, not CPE at 4.9%, those same investors had 1.2% of their assets which would imply today if they just got back to wait another $400 billion of buying in commodity indices and if you, certainly the impact models that we run what are, what are you that GSER or BCOM would double or triple. So you’ve got, if I just look at where asset managers are, the one thing that they should be invested in, they’re not invested in, probably because they’re hearing these assurances that inflation is transitory so you’ve got this massive short, really, in the commodity complex, a massive short there so that makes me think that and I’ll look at the balances in a variety of commodities and they’re all so razor thin, they’re all so razor thin. And this is just what happens if institutional money would get to where they should be given the level of real rates. What happens if the Reddit crowd ever gets into commodities, god forbid, if the bullies, the financial markets, ever were to take it on for instance like retail did back in the 70s.

ANDREW ROSS SORKIN: Explain what you mean by that.

PAUL TUDOR JONES: What I mean is, is that commodity, commodities are finite supply, small markets generally speaking, and if we ever get an inflationary psychology, like for instance, we did when I was in my 20s back in the 70s if we ever get that again and if you ever got retail actually nervous about inflation then the one thing that leads inflation which is commodity prices or the it’s, the it’s the easiest tautology there is, those things can literally scream double or triple with no problem whatsoever.

ANDREW ROSS SORKIN: So you’re working but you’re worried about the Reddit crowd getting involved in commodities right now.

PAUL TUDOR JONES: No, I’m, I’m saying that right now, I would be a lot, look, I’m, I think I’m the most conservative investor in the world, that’s a hedge fund manager by definition hates risk, loves edges, loves competitive edges, does great reward risk trades. I would be really concerned about arguing that inflation is transitory when I know that you’ve got. Look, think about it, we have a just in time mentality, we have inventories at record low, we have demand screaming and we have people who are really under invested where they should be given the valuations of a variety of financial assets.

ANDREW ROSS SORKIN: You said if the, if the Fed doesn’t make any moves this week that it’s going to be a green light.

PAUL TUDOR JONES: Well for me, it’d be a green light.

ANDREW ROSS SORKIN: Well, the question is, so it may be a green light temporarily but you’re also suggesting that there’s going to be a hard stop at some point, that it’s going to create an even bigger problem. So how do, how is a long term investor think about that?

PAUL TUDOR JONES: Listen I have maintained I’m so happy I don’t have to run a Pension Fund. I don’t know how you’d invest those assets when valuations for both interest rates and stocks are at, if you combine the two, they’re, they’re so overvalued they’re at 100-year highs. I don’t know. I don’t know what you do. I know one thing I’d want to do is the one thing that can hurt that is inflation. I’d have as many inflation hedges on as I possibly could. I sit on, you know, the investment committee of these not-for-profits and it’s really difficult to try to explain to some of the board members of our not-for-profits, gee maybe now’s not the best time to be invested in a variety of financial, maybe we should be, maybe we should own commodities at this stage of the game. Can I just say one last thing, the December 2018 meeting, do you think about that meeting that the Fed had with pretty much the same board makeup, they had a lot of incoming data between that meeting and the one prior to that, stock market was down 12%, GSCI was down, commodities were down 20%, the credit markets were frozen, but they went on in height because they were locked in to this linear belief that I can have a forecast, and that we should stay with it. The predictability was more important than reactivity. So I think they had the same, in seven months later, they had to reverse course and take that back. I think we’re confronted with exactly the same situation right now.

But while Tudor Jones sees an inflation psychology building up, as I explained last week in a long and detailed comment, you need to beware of US-centric inflation hysteria.

Moreover, nothing cures high prices like high prices and when it comes to cyclical inflation, lumber is showing us the future as prices have declined significantly from sky-high levels.

Also, on Monday, Brian Romanchuk of the Bond economics blog wrote a great comment on why forward-looking markets should not react to lagging data, ending on this note:

It is a mistake to argue that inflation does not matter under any circumstance for bonds, but you need to be extremely careful about what inferences you draw. Markets are hard to beat, and some market participants can forecast inflation data a few months ahead relatively accurately. This means that anything you read about in the papers about the latest CPI print is likely to have already been priced in.

It's mind-boggling to me when people think they're smarter than the bond market or that the "bond market has it wrong" or that the "Fed has skewed the bond market".

The Fed doesn't control the bond market, it's the other way around, no matter what their QE program is.

I'll end it on that note. Let me take the time to thank all of you who support this blog by donating at the top under my picture using the PayPal options. I truly appreciate those who appreciate the work that goes into these daily comments on pensions and investments (that's right daily, one person, every single day).

Below, St. Louis Fed President James Bullard told CNBC's "Squawk Box" Friday. "We were expecting a good year, a good reopening, but this is a bigger year than we were expecting, more inflation than we were expecting, and I think it's natural that we've tilted a little bit more hawkish here to contain inflationary pressures." Bullard also weighs in on the Fed's purchase of mortgage-backed securities.

Next, watch Federal Reserve Chairman Jerome Powell hold a press conference earlier today after the central bank wrapped up its two-day policy meeting on Wednesday.

Also, on Monday, hedge fund manager Paul Tudor Jones, a prominent Wall Street figure who called the stock market crash in 1987, told CNBC's "Squawk Box" Monday if the Fed treats higher prices with "nonchalance," it would be a "green light to bet heavily on every inflation trade."

Lastly, CNBC's "Halftime Report" team discusses its investment strategies. Ritholtz Wealth Management CEO Josh Brown offers his take on the dangers of ransomware and where he sees it opening investment opportunities. And Market Rebellion's Pete Najarian offers his thoughts on Nvidia.