The Fed Isn’t in a Hurry to Hike, but It Isn’t Done Either
Fed Governor Waller signals more rate hikes, oil jumps and junk bonds flash a warning.
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After a difficult day Wednesday, the market is indicated lower again early Thursday. A strong auction of 10-year Treasury notes helped stem some of the damage Wednesday, but bonds are lower overnight after comments from Fed Governor Christopher Waller.
Speaking in Istanbul, Waller said the Fed will need to keep raising interest rates to bring inflation back to its 2% goal, but that those hikes “do not need to come at consecutive meetings.” Several of his colleagues have recently made the same point. However, he added that the increases “should be in place in an acceptable period of time.”
Waller also pushed back on the idea that last month’s hike was a reaction to a single hot inflation report. He pointed to a “preponderance of evidence over several months” that persistent pressures, including high energy prices from the Middle East conflict and the cost of the AI buildout, were “swamping the fleeting signs of progress.” The AI spending that has carried the indexes to highs is now part of the Fed’s case for higher rates.
The Fed isn’t in a rush to hike rates, but it isn’t done, and the market has to live with not knowing when the next hike will come. Markets do not like uncertainty, and interest-rate uncertainty is particularly onerous.
Oil Adds to the Pressure
Oil is up about 2% Thursday morning, with Brent crude around $102 a barrel and West Texas Intermediate near $90. Attacks on tankers in the Strait of Hormuz and the Gulf have picked up and are now as frequent as at any time since the war began.
Hurricane Isaias has shut in about a quarter of U.S. Gulf of Mexico oil production. U.S. crude inventories also fell more than expected last week, and supplies of diesel and jet fuel are well below normal for this time of year.
The refined fuel problem I wrote about Tuesday isn’t going to improve any time soon, which keeps the pressure on inflation and the Fed.
Chips Slip
The VanEck Semiconductor ETF (SMH) is trading lower and filling a recent gap on the chart. Wednesday I asked how much longer the AI leaders can serve as the market’s defensive trade, and this is another sign of strain.
Chips have been a key part of the AI leadership that has kept the indexes near their highs. If those leaders start to slip, there isn’t much else holding the indexes up.
Another Warning From Under the Surface
Market pundits continue to produce reports on the disparity between the indexes and the average stock. The latest, from RenMac, notes that the SPDR S&P 500 ETF Trust (SPY) is within 1% of its 52-week high while the iShares iBoxx $ High Yield Corporate Bond ETF (HYG), which tracks junk bonds, is within 1% of its 52-week low. Of the last five times that happened, stocks lagged over the next quarter in four, with a median loss of 3.5%, against a typical quarterly gain of 3.7%.
As I said Tuesday about similar studies, five examples aren’t enough to say anything with confidence. Junk bonds are also being pushed lower in part by rising interest rates, not only by worries about the companies that issued them. Still, it adds to the long list of signs that the indexes are hiding a lot of stress underneath.
Game Plan
It is a messy and unsettled market, but the disparity between the indexes and the average stock holds the seeds for some robust trading when it starts to reverse. We don’t know how the market will correct this distortion, but cycles like this always turn, and the opportunity is in catching the shift as it begins to take hold.
The immediate question is whether earnings season, which starts with the big banks next Tuesday, will be the catalyst that speeds up that process. I’m taking some hits to existing positions, but I’m holding a lot of cash and I’m optimistic about the opportunities that lie ahead.
At the time of publication, Rev Shark had no positions in any securities mentioned.
