Advisors in Focus- March 16, 2021

Fed Day.

It’s a day where one word, phrase or even Jerome Powell breathing could send ripples through the entire market.

Fed Day’s do not have to be a painful process. Preparation allows advisors to manage through the minefield of commentary and projections and pivot portfolios. 

In today’s Advisors in Focus, we preview the upcoming Fed Day. We look at recent comments by Powell and how any changes in verbiage or projections could rattle rates and your portfolio. 

The Federal Open Market Committee releases its latest directive tomorrow at 2pm ET. This is a quarterly release which means the Fed updates its projections for inflation, GDP, unemployment, and the infamous “dot plots”.

Fed Chair Jerome Powell will take the podium 30 minutes later to discuss the latest decision by members. After a brief introductory statement, Mr. Powell will take questions from the press. 

Outside of FedEx (FDX) and Nike’s (NKE) earnings and the quadruple options expiration on Friday, there is little to deflect attention. The Fed is the only game in town on Wednesday.

TrackStarIQ Data

Here are some highlights from ETF searches this week –

RankTOP ETFs BY ALL FAs (Total Traffic) Last WeekTickerTOP ETFs BY FAs w/ AUM >$1 bln (Total Traffic) Last WeekTickerTOP ETFs BY RETAIL (Total Traffic) Last Week Ticker
1SPDR S&P 500 ETFSPYVanEck Vectors Gold Miners ETFGDXSPDR S&P 500 ETFSPY
3First Trust Health Care AlphaDEX FundFXHSmallcap ETF VanguardVBARK Innovation ETFARKK
4ARK Innovation ETFARKKUS Aggregate Bond Ishares Core ETFAGGProShares Ultra VIX Short-Term FuturesUVXY
5First Trust Amex Biotechnology IndexFBTDirexion Daily Financial Bull 3X SharesFASProShares UltraPro QQQTQQQ
6Vanguard Emerging Markets Government Bond ETFVWOBDirexion Daily Regional Banks Bull 3X SharesDPSTMicroSectors FANG+? Index 3X Inverse Leveraged ETNFNGU
7ProShares UltraPro QQQTQQQInvesco QQQQQQARK Fintech Innovation ETFARKF
8ProShares Ultra VIX Short-Term FuturesUVXYFinancial Bull 3X DirexionFASDirexion Daily Semiconductor Bull 3x SharesSOXL
9VanEck Vectors Gold Miners ETFGDXVanguard Small Cap ETFVBTechnology Select Sector SPDR FundXLK
10Roundhill Sports Betting & iGaming ETFBETZiShares Select Dividend ETFDVYiShares Russell 2000 ETFIWM
11iShares Silver TrustSLViShares Core U.S. Aggregate Bond ETFAGGEnergy Select Sector SPDR FundXLE
12iShares Edge MSCI USA Momentum Factor ETFMTUMS&P 500 Financials Sector SPDRXLFU.S. Global Jets ETFJETS
13Invesco Dynamic Leisure and Entertainment ETFPEJMicroSectors FANG+ Index 3X Inverse Leveraged ETNFNGUiShares Silver TrustSLV
14U.S. Global Jets ETFJETSiShares MSCI Pacific ex Japan ETFEPPSPDR Gold TrustGLD
15ARK Fintech Innovation ETFARKFiShares Silver TrustSLVARK Genomic Revolution ETFARKG
16First Trust Capital Strength ETFFTCSPacific Ex Japan Ishares MSCI ETFEPPVanEck Vectors Semiconductor ETFSMH
17VanEck Vectors Gaming ETFBJKMicrosectors Fang+ 3X ETNFNGUiShares 20+ Year Treasury Bond ETFTLT
18Financial Select Sector SPDR FundXLF SPDR Dow Jones Industrial Average ETFDIA
19Energy Select Sector SPDR FundXLE Financial Select Sector SPDR FundXLF
20Direxion Daily S&P Oil & Gas Exploration & Production Bear 2x SharesDRIP ARK Web x.0 ETFARKW

The Pulse

To his credit, the Fed Chair has not shied away from market commentary. This is a chronological look at his recent public statements. 

January 27- Fed Decision

  • The Fed downgraded its economic outlook. It stated that the economic recovery ‘moderated’ compared to ‘continued to recover’ in the December meeting. 
  • The statement added the term “progress in vaccinations”. This suggested the Fed is watching this rollout as a key gauge for economic growth. 
  • Powell & Company stated the ongoing health crisis would weigh on inflation “in the near term”. This was the first indication that the Fed would flag volatility in pricing pressures.   
  • The Fed made no changes to rates or its $120 billion monthly asset purchase program ($80 billion Treasurys and $40 billion mortgage-backed securities).
  • Powell hammered home the idea that the Fed remained a long way from monetary policy and inflation goals.
  • The S&P was rejected at the 3850 level that day. It would end the day 20 points off the high, sliding back to test the 50-day moving average two sessions later. It firmly held this level.
  • The 10-year rested at 1.00% that day. Its lowest level since the January 6 Capitol Hill uprising. We are 59 bps higher since that meeting.

February 10- Powell at the New York Economics Club

  • The Fed Chair provides an annual market update at the New York Economics Club. It is widely followed by the markets.
  • The title of his speech was “Getting Back to a Strong Labor Market”. This highlighted Powell’s focus on the jobs market. Recent shortfalls in initial claims and the jobs report provided the Fed with cover to maintain an uber dovish policy. 
  • Powell highlighted the strong jobs market over the past five years and the fact that it did not drive inflationary pressures. The takeaway was the Fed could continue its current path to achieve full employment without generating pricing pressures.
  • The S&P pushed into the 3900 level ahead of the speech. It would fall on the day, eventually rolling over by the end of the week.
  • Selling intensified at the back end of the month. The S&P slipped back for another test of its 50-day moving average. 
  • The 10-year closed at 1.13% that day. It launched 12 basis points higher over the next three sessions. This was the start of the parabolic run that roiled markets.

February 23- The Humphrey Hawkins Testimony

  • The Humphrey Hawkins Testimony was created in 1978. Under the law, the Fed Chair goes in front of Congress twice a year to provide an update on monetary policy and the economy. 
  • Powell acknowledged a stronger economy with an addendum that the recovery was far from uneven and incomplete. 
  • Powell discussed the strong demand at the short end of the curve in treasuries. This is important as the Fed does most of its borrowing in short-term yields. The comment intended to ease worries that the rise in yields would make debts unsustainable. 
  • When pressed on the rise in rates, Mr. Powell stated that it reflected stronger confidence in the economic recovery. He deflected concerns around inflation saying it was not evident and the Fed had tools to deal with pricing pressures.
  • The 10-year yield would launch another 12 bps to 1.45%. This marked a 52-week high in rates. 
  • The S&P fell 85 points from session highs to end the session lower. The S&P slipped below the 50-sma a few days later. The S&P fell to 3804 the following day before bouncing back above the 50-sma. 

March 3-  Fed Chair Powell at The Wall Street Journal Jobs Summit

  • Mr. Powell discussed labor markets, the economy, inflation, and central bank policy stance.
  • Powell doubled-down on inflation comments, noting the central bank was comfortable with it running above 2% for an extended period. 
  • Markets? You guessed it, they sold off that day. The S&P tumbled below its 50-sma to 3720. 
  • The 10-year yield? It fell to 1.40% ahead of his speech but would resume its upward momentum, rallying 20 bps in two days to hit post-pandemic highs. 

Expectations for March 17 Fed Day

Now we are caught up with the ebb and flow of Fed speak. These are the key items you want to watch:

  • The Economy- The Fed releases its Beige Book two weeks ahead of the Fed decision. The Fed stated the economy “expanded modestly” which is Fed-speak for a deceleration. We would expect to see cautious commentary around the economic recovery. This provides the Fed with some wiggle room. 
  • Inflation- In the January directive the Fed said, “Weaker demand and earlier declines in oil prices have been holding down consumer price inflation”. We saw Lagarde discuss transitory issues’ impact on the inflation front. We expect Powell to follow a similar path. 
  • Asset Purchase Program- We would not expect the Fed to budge on its $120 billion program. The Fed will avoid any commentary around a taper as the fear of comments by Ben Bernanke in 2013 continue to ring in the Fed halls. 
  • The Twist- Speculation that the Fed could perform an “operation Twist” has been rampant. In thsi scenario, the Fed emphasizes purchases in long-dated bonds (7-year and above in duration). This keeps the long end of the curve lower. This stabilizes the housing market. It also flattens the curve which hurts baking profitability. We think it is too early for the Fed to take this step but it is possible.

Here is a look at the Fed projections:

The Dot Plot

Some investors choose not to play the word game and look at the Fed projections. The FOMC participants’ assessment of appropriate policy or the more widely used term ‘dot plots’ is a key data point for markets.

The Fed introduced the dot plot in 2012. It is a visual representation of when Fed members expect rate hikes. Powell can say the Fed is “not even thinking about thinking of raising rates”. The dot plots tell us when they are thinking about thinking of raising rates. Let’s take a closer look: 

The December projections suggest there is little appetite to raise rates until after 2023. No FOMC member sees a move in 2021. Only one member expects to raise rates in 2022. Three members expect to see one rate increase by 2023. One lone member expects the Fed would implement two rate increases.

Markets want to see if the recent rate rally forced any members to move forward rate increase expectations.

  • December Dot Plot Projections– 
    • 2021- Unanimous, no raise
    • 2022- One member expects rates to range from 0.25-0.50%
    • 2023- Three members expect one rate increase and one member expects two

The CME Group’s FedWatch Tool shows the market expectation for rate changes. It is a helpful companion to see if the Fed and markets are on the same page. The FedWatch tool calculates unconditional probabilities of FOMC meeting outcomes based on Fed Funds futures contract prices. 

The CME Group sees a 9% chance the Fed would raise rates this year. In the past, 60% has been the threshold that has forced the Fed to move. 

We expect to see some dots move up in 2023. If we are right, the market reaction to this will be the key event. Have we priced in a rate hike at this point? That answer could come tomorrow.

The Fed Projections

The Fed will update its December projections for GDP, Unemployment, and Inflation. A rise in pricing pressures will put inflation projections in focus. 

Last Thursday, the European Central Bank noted inflation was subject to considerable volatility over coming quarters. However, underlying pricing pressures remain subdued due to weak demand. 

ECB President Christine Lagarde used the term “transitory” to describe pricing pressure. The next few months, inflation compares to a period that saw demand dry up due to the spread of the coronavirus. 

We can expect to see a spike in headline inflation figures in the coming months. This will worry the markets. The Fed wants to make sure that people are aware that these spikes in inflation reports are only temporary and it will not force the Fed to act. This is a key argument for Powell to win. 

The focus on inflation will be a key driver. December inflation projections for 2021 are in the range of 1.7-1.9%. It rises to 1.8-2.0% in 2022 and 1.9-2.1% in 2023. These projections will be a focal point for participants. 

The Fed has hung its policy on a weak job recovery. We expect to see the Fed revise its Unemployment projections higher for 2021. This will provide the reason why it can continue to keep its uber dovish monetary policies. 

A lower GDP outlook for 2021 can also provide some cover for Powell and company. 

A lot to digest but understanding the concepts and reason for Fed actions is paramount for understanding the Fed’s direction. 

Economists argue that the bigger Fed meeting comes in May. The idea that the Fed will need to address rising inflationary pressures. The next couple of months represent a very low comparable from the prior year. The initial impact from the pandemic drove prices lower (recall oil at -$40 a barrel in April).

The ability for the Fed to present these pricing pressures as transitory may be the biggest story for the markets this spring. 

Tomorrow’s Fed meeting stands as the first major opportunity for the Fed to create the narrative around inflation. May could be the more important meeting, but we are taking one meeting at a time. And tomorrow’s looms large for a market glued to rate watching. 

Five questions advisors may see from clients:

  • I am thinking of buying a house, will the Fed decision impact mortgage rates?
  • Should I be worried about inflation?
  • What does the Fed mean when it says inflation pressure is “transitory”?
  • Which stocks benefit when rates rise?
  • How will the rise in rates impact the stock market?

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