Blow It All Up

I thought it would be really hard to top Monday’s Parliamentary shit show, but it looks like I was wrong. Today at 2:00 pm the US Federal Reserve met, and boy oh boy, did shit get real – real fast.

As part of the Fed meetings, the minutes are released along with the statement, and in todays minutes it showed that the Federal reserve is going to reduce rates less than market expectations in 2025 – a whole 50 bps less. As I have often said, and you are probably tired of hearing, is that it matters not what the Fed, or the BOC, or a company reporting earnings for that matter says – but rather what the market expectation was. If the news is what was expected, it is a big yawn. However, when the news is mis matched to the market, you get a powder keg explosion. Lets jump right in.

When central banks speak, they parse their words very carefully – unlike a blogger you may know. They scrutinize every single word, they look at how it could be interpreted, they look at how it will be viewed. Today’s speech from Uncle Jay in the US was a great example of what the industry generally calls ” Fed Speak “. When the minutes were released today there were 2 massive items in the statement that caught the markets attention:

1. The Fed expects 2, quarter point reductions in 2025, as opposed to the 4, quarter point cuts it expected in September. Basically, there will be 50 bps of cut instead of 100 bps of cut. Gee whiz, I wonder if inflation going back up has anything to do with it? So, markets were pricing in rates 100 bps lower, and now they are expected to be 50 bps lower. Now markets have to re price every financial instrument by 50 bps. Future earnings, forward cash flow projections, exchange rates, currencies, bond yields, you name it, and it all has to be re priced to reflect the new expectation. Markets were way off.
2. Lets also remember that the Federal Reserve has a dual mandate of steady prices ( inflation ) and employment. Since employment seems to be doing okay, the Fed doesn’t really need to pull any levers to get people to work. In fact, the US unemployment rate is fairly decent considering. The Fed statement alluded to the fact that the Fed is more worried about the return of inflation at this juncture and fears that dropping rates too fast would re ignite inflation forces. Inflation around the world is starting to creep back, and the Fed alluded to it being more of a concern than it was before.

The Federal Reserve is in a great spot right now. They have the option to lower rates if need be, but are not really in a position where they must lower rates. Contrast this to Uncle Tiff who almost has his hand forced to lower rates at every meeting due to the declining economy, and increasing unemployment levels ( even though unemployment is not a BOC mandate, it goes hand in hand with the overall health of the economy ).

After the release of todays statement we saw a lot of things happen, and I am going to break them down for you and give you my 2 cents worth on them.

1. CAD got whacked faster than a US healthcare CEO, falling almost a full 1% in 2 hours. The CAD just dropped below 70 cents on Monday, and is now set to drop below 69 cents. A little over 1.5 cents of decline in 3 days. Makes complete sense as the US slows interest rate drops and the BOC has to keep rates going down. This will increase the spread between the US overnight rate and the Canadian overnight rate. I really am at a loss for words to describe the complete gutting of the CAD in 2024. The currency market is telling you there is a lot of pain ahead. At some point we see a technical bounce, but that day ain’t today, and tomorrow doesn’t look good either. These currency moves have me mildly worried.
2. Stocks took it on the chin after the 2 pm announcement with the Dow Jones dropping over 1100 points, and the S and P 500 dropped almost 3%. This makes sense as stocks now have to discount higher future interest rates. Stocks are a function of the future discounted earnings model, and the higher rates are expected to be, the lower stocks go to make up for that fact. Honestly, stock markets have been flying high this year, so to see this pullback does not surprise me in the least. Stocks have been looking for a reason to pullback and reset, and todays Fed announcement gave the market that perfect opportunity. The stocks that were down the hardest were the same ones that were up the most post election, so this is a nothingburger. In fact, Dow and S and P futures have already rebounded nicely – but whether they hold the gains into tomorrows close is the real question.
3. Interest rates. Holy smokes, how quickly things changed. After 2 pm the US 10 year added 12 bps, and the US 2 year added 10 bps. The US 10 year yield is now hovering at a critical 4.50% which is the resistance level. A move through 4.50% takes us a lot higher on US 10 year notes, and by default Canadian 5 year bonds. Canada 5’s were up a whisker over 9 bps to finish above the phycological 3.00% level. Just a week ago we were looking in the 2.79% range, and here we are planted firmly above 3%. I said a few weeks ago we were going to bounce around in this range – and here we are bouncing around in this range. Never forget that we went up rapidly after the election, we went down just as quick a couple weeks ago, and here we are bouncing right back up. Look for lenders to be increasing fixed rates in the coming days, so get those pre apps in, and send in any rate drop requests tonight or tomorrow before rates climb. I have long been in the camp of rates higher (than most think) for longer (than most want). Today’s Fed meeting just showed that I am not alone in that thinking, and the bond market is now reacting to the pretty good potential of higher than anticipated rates. If we see the US 10 year yield clear the 4.50% range, then the next resistance level comes in nicely around 4.80%, or a full 30 bps higher. If that were to happen, then the Canada 5 could easily add 20 to 25 bps to settle in the 3.25% to 3.30% area. Rates moving and bouncing all around are probably my biggest concern as it makes borrowing harder, and economies are driven on borrowing money. Higher rates are also a headwind for mortgage brokers, housing, and homeowners. Remember how everyone just knew that rates would be lower in 2024? Remember all the Tik Tok dances? Remember how people like me were stupid and crazy for saying rates may actually go up? They key level for me is 3.171%. That was the 5 year bond yield on Jan 01 2024. With the 5 year hovering at 3.041% tonight, there is a real possibility that the Canada 5 year yield closes the year HIGHER than where it started. Imagine the wheels falling off the economy like they did and rates ending the year higher? Imagine the BOC cutting overnight rates by 150 bps and the 5 year bond is still higher? Imagine all those savvy, sophisticated realtors on Tik Tok who knew rates were going down being wrong?

After the gong show that was Monday in Canada, we really needed things to calm down. We needed things to smooth out, volatility to go away, and to have a nice sail off into the year end. Jay Powell decided he wanted to end the year with a bang, and a bang he did.