Christmas Come Early!

As long as I have been alive, Christmas has fallen on December 25, and was always symbolized by a fat man in a red suit. This year however, it appears that it arrived on December 13, and was brought by a man in a banker’s suit.

Yesterday Jerome Powell of the US Federal Reserve gave a speech after the Federal Reserve Open Market meeting – and boy what a speech it was. What will probably go down as the 2023 ” Fed Pivot ” it had everyone seemingly jumping for joy. Mr. Hawk himself, suddenly had some pretty good news, for, well…..everyone. Within minutes of the press conference yields plummeted across all time frames, stocks rallied hard, with the Dow Jones ending the day up over 500 points. Oil rallied, gold shot up, hell – even the long beaten down asset class of crypto currency shot up, some coins adding 50% to their value within the hour.

Canadian bonds did not miss out of the festivities, and the Canadian 5 year dropped 20 bps in a matter of minutes, dragging down other longer dated bonds at the same time. Everyone is now busy revising their interest rate forward assumptions now, with Fed rate hikes over, and cuts being factored in as soon as May 2024 in the US. Previously it was looking like September 2024 before the Federal Reserve was going to cut. All of this in a US economy that is pushing out 5% GDP growth – far above Canada’s meager 0.00%. So, if the Fed is now looking to cut early, and often ( Powell referenced 3 cuts in 2024 alone ) in an economy pushing 5% growth a year, that should mean Canada cuts earlier, and more with almost no growth.

So, all good news, right? Maybe, but I am skeptical. Up until yesterday at 2 pm, the higher for longer theme was the narrative, and while no one expected the Federal Open Market Committee ( FOMC ) to hike, no one expected the dovish language that followed. In fact, this is the most dovish a central banker has been – ever, with inflation well above the central banks target. So what exactly caused the about face? Why the full 180? One thing is for sure – the reaction by all markets, whether it be commodities, stocks, bonds, currency – you name it – no one was positioned correctly for the news that came out, which means no one was expecting it. In previous blogs I went over why expectations matter. Yesterday was a great example of what happens when Mr. Market gets it wrong, and the positioning is all off.

Central banks only have 2 tools in their tool belt – policy, and talk. Policy is when they move rates, somewhat akin to using a sledge hammer on a nail. Raising rates is a very blunt instrument that is felt by everyone – even the people not responsible for causing inflation. Talk is number 2. Central bankers can lead a conversation, direct a narrative, and generally convince people with their words of the actions they want them to take. If a central banker says inflation is too hot, and needs to be cooled, then generally it leads the crowd to think rates will rise.  So, when a central banker comes out and does an about face, they start to lose credibility in the eyes of the market. This means the next time they talk – the crowd may not be so inclined to listen. 

So, my question is a simple one: What does Jay Powell see in the future ( or potentially in the current data ) that led him to an about face? What is so important that he thinks the Fed needs to take their foot of the brakes of the economy, and not only coast, but switch the foot to the gas pedal of lower rates? The Fed spent 2 years pushing the ” higher for longer” ” inflation must come down ” narrative, and all of a sudden we reverse course? 

While everyone is busy living it up, and partying like its 1999, I am wondering if there is something we are not seeing. Of course in 30, 60, and 90 days time we will see the data that the Fed sees now, and maybe that will answer the question, but until then it makes a person wonder. The ” risk on” trade is clearly in full force with all assets rallying, and providing a very nice year end bump to investment portfolio’s.

While I had always held firm in my belief rates would be lower at year end, and I was steadfast in my belief that we topped out on the Canadian 5 year at the 4.44% range in early October ( no matter how much arguing people did with me ) I am shocked at how quickly the Canadian 5 year yield has gone from 4.44% down to 3.24% today. 120 bps in a little over 60 days is not insignificant. Use this opportunity to lock in lower rates on rate holds for your clients. 

In typical contrarian fashion, I want to remind you that while the party rages on, and it appears to just be getting good, the harder the party – the harder the hangover. While it is far from me to attempt to remove the punch bowl at said party, I would like to remind everyone that the bond market is telling you the hangover is coming, and it is gonna hurt. When rates drop as quickly as they have – especially in the last 30 days, the bond market is signalling that there could be some storms on the horizon. While both Canada and the US have avoided a recession so far – no matter how many people have called for one, luck can only get you so far, and at some point the day of reckoning comes.

While everyone else is betting on a rebound in the housing market, lower rates, and the return of the good ol days in Canadian housing, the bond market may have other plans. House prices are down, average DOM have increased, power of sales are filtering through the legal process, banks are padding loan loss provision accounts, growth is slowing – or has outright stopped in Canada, and people are in a pinch. Lower rates may be a help to a lot of people, but it will not be the panacea that saves everyone. 2 years of higher rates has taken its bite out of budgets, and it will be a long road to rebuild.

Get out, help your clients through the bad times, become a master of budgeting, and help the clients that need the help as best you can. Remember – you are not Santa Claus, and you cannot help everyone.