Equities Are In A Holding Pattern
Equities are in a holding pattern as the equity market is tethered to the Fed’s actions. This unholy relationship did not exist prior to COVID. Sure, monetary policy has always influenced the capital markets. However, now it seems that fundamentals barely matter when valuing risk assets as fundamentals have been replaced by monetary policy / Fed watching. I don’t see this changing until meaningful liquidity is pulled from the system. Thus far the Fed has pulled approximately $1 trillion out of the system after having added more than $5 trillion during 2020-2022. A severe and pronounced recession / depression would suck liquidity from the system and restore order. However, I don’t believe that policymakers in Washington (fiscal side) nor the Fed (monetary side) have the stomach to weather a deep recession, particularly in an election year. This means more stimulus is coming in the form of deficit spending. Deficit spending means that Treasury debt will continue to grow well above $34 trillion, the Dollar’s value will continue to erode, and that the price of goods and services will continue to climb.
What will the Fed do next? Under Chairman Jerome Powell, this Fed is highly reactionary and anything but strategic:
Will the Fed raise rates on March 20th? No.
Will the Fed cut rates on March 20th? Likely not. However, bond values are declining with the 10-year Treasury yield having climbed to 4.3%. This means that Bank unrealized losses are growing from 12/31/2023 levels. Exactly what the Fed does not want to see. Therefore, I could see the Fed lowering rates by 25 BPS on March 20th should the 10-year Treasury yield rise above 4.5% between now and March 20th.
Will the banks struggle in 2H March once the BTFP expires on March 11th? Yes.
Will enough banks fail to force the Fed to cut rates at the May 1st FOMC meeting? Possibly. I give it a 50% probability at this juncture.
Should banks struggle in March/April to the extent that the Fed feels the need to cut, it won’t cut by 25-50 BPS. Rather, the Fed will cut quickly and sharply.