- Black Friday saw more selling than buying in financial markets
- Fed members may soon favor taper approach
- Fed Analysis Tool: Following the Fed Using Returns
On Friday, the market experienced wide selling in stocks, yields and commodities. The news of the Omicron COVID-19 variant caused some panic in the day with low volumes. The Dow Jones Industrial Average (DJI) fell 2.5%, its biggest one-day drop since October 2020. The S&P 500 (SPX) fell 2.3% and the Nasdaq Composite (COMP: GIDS) fell 2.2%. In other markets, crude oil (/CL) fell over 11% and the 10-year Treasury yield (TNX) declined from 1.64% to 1.48%.
However, it appears that cooler heads may be prevailing as equity index futures and oil prices rebound ahead of the open. With more investors returning from vacation, the market can better reduce the gravity of the news. The Cboe Volatility Index (VIX) which went above 28, has fallen over 15% prior to the open. Of course, as the Omicron version is new, more news will emerge, so we’re not out of the woods just yet.
The variant news didn’t seem to keep consumers out of the store because more shoppers were spending more time and money in brick-and-mortar stores than last year. According to the Wall Street Journal, there were fewer discounts due to the early buying season.
The earnings calendar is busy this week, but big announcements are few and far between. Before the bell, Chinese EV maker Li Auto (LI) reported better-than-expected earnings and revenue, which prompted the stock to rally more than 9% in premarket trading.
As you probably know, the Federal Reserve is purchasing Treasury and mortgage-backed securities to help stimulate economic growth by providing liquidity to the money markets and keeping interest rates low along the yield curve. The Fed announced earlier this month that it would begin reducing or reducing the amount of bond purchases in December, with purchases expiring in June of 2022. However, it already takes a push to accelerate the taper.
Two weeks ago, Atlanta Fed Chairman Bostic gave a speech saying the Fed should consider accelerating the taper due to rising inflation and a stronger employment picture. Last week, San Francisco Fed Chair Mary Daly agreed that tapers should be accelerated if inflation continues to rise and employment continues to rise. However, it’s not just Fed members who are talking about it. On November 15, Richmond Fed Chairman Tom Barkin also said he would be ready for faster tapering talks if the data backed it up. On November 19, Fed Governor Christopher Waller said he wanted to “go early and go fast on tapering.” So, it seems as though the appetite for speeding up tapering is on the rise.
So, what is the data showing? Last week, just before the Thanksgiving holiday, weekly jobless claims fell below 200,000, a 52-year low. The PCE Price Index showed an increase of 5.3% in inflation from October 2020 to October 2021. This week, we’ll see more jobs data with the big November Employment Status Report on Friday. The November Consumer Price Index (CPI) is scheduled for release on December 13. Then the Fed will meet again on December 15, where it will determine whether it wants to accelerate the taper.
Treasury yields are already turning as markets anticipate the Fed’s tapering plans. Last week, President Joe Biden re-nominated Fed Chair Jerome Powell for another term. Yields rose on the news because the bond investor was viewing Powell as more bullish than the other frontrunner, Lyle Brainard. The biggest movement has been on the front side of the curve, with one-year Treasury yields rising by 40% and 3-month, 2-year and 3-year yields rising by 20%.
The 10-Year Treasury Index (TNX) tracks changes in the 10-year Treasury yield. TNX hit an all-time low in March 2020 in response to the actions of the Federal Reserve and Congress regarding the COVID-19 pandemic. However, TNX has grown into the congested territory it has been in since the 2008 credit crisis. In the past, this has been a difficult area for TNX break above, but with tapers, there could be less resistance here as the Fed will buy less.
Doh: Earlier in November, Businesshala reported that 2-year Treasury futures (/ZT) had become a popular trade for hedge funds speculating on the taper. These investors have been “two” short in anticipation of increasingly tapering plans and the prospect of the Fed raising rates in 2022. The 2-year yield has gone up from 0.27% on 1 October to 0.60% on 23 November. This is a change of about 122%. Friday’s move may have scared some hedge funds, but Monday’s open is already seeing a rebound. If hedge funds begin to exit two, it could be a sign that rates may return to normal.
Fed Fund Futures: Fed watchers can see how futures markets are forecasting potential interest rate changes CME Fedwatch Tool, It allows users to monitor Fed interest rate hike prospects.
Looking at the tool’s forecast for June 2022, it is estimating that there is a 19.5% chance of the federal funds rate being between zero and 25 basis points (bps), which simply means no change, 25 more There is a 45.8% chance of a change or one rate increase occurring between 50 bps, a 28.7% chance of being between 50 and 75 bps, which is two rate hikes or one major increase, and 5.8% likely to be between 75 and 100 bps. Adding up the estimates above 25 bps gives us an 80.5% chance that there will be at least one rate hike by June 2022. Looking at December of 2022, it is currently reading a 98.4% chance of a rate hike and 88.8%. Possibility of two rate hikes.
While the tools can be helpful, it doesn’t guarantee any rate hikes. The Fed has several members who work to effect rate changes, and 12 of them vote on the decision. Although the futures market may be part of the decision-making process, it does not constitute the decision. As the data changes, the probabilities also change. This is one reason why the tool can be helpful; Whenever new information comes in you can refer to it to see how the information might influence these decisions.
Two and Tens: The “2s and 10s” is a ratio that measures the difference between the 2-year Treasury yield and the 10-year Treasury yield. The ratio is often used as an indicator of the stability of the yield curve, even though the yield curve from one month to 30 years usually has 12 points. In general, a sharp yield curve is usually considered bullish, and a flat or inverted curve is seen as bearish.
If tapers continue, looking at 2 and 10 can help investors get an idea of how bond traders are reacting to economic changes. If the ratio of 2 and 10 is above zero, it is considered normal. The ratio of zero is flat. A ratio less than zero is the inverse. Today the ratio is around one, which many would see as a good sign for the economy. The last time it was below zero was in August 2019, just before the pandemic’s bear market. In fact, the yield curve has a good track record of warning about bearishness, but it is not a very good timing tool. This could be reversed well before the recession hits.
These are just a few more tools to add to your analysis toolbox as you build your portfolio.
TD Ameritrade® Commentary for educational purposes only. Member SIPC.