It Turns Out That They Loved Warsh

I feel remiss that I could not comment in real time on yesterday’s stunning rally, but I was privileged to be invited to participate in the SEC’s Roundtable on Preparations for 24-Hour Trading and thus fully committed to that event.  There was indeed a stunning turnaround after the lukewarm response to Chair Warsh’s press conference, though the magnitude may have had more to do with traders’ continuing propensity to chase rallies than a sober reassessment of the fundamentals.  And this morning’s very modest profit-taking amid sharply higher yields is another sign of the “ratchet effect”.

It was interesting to piece together yesterday’s action with limited access to market data (I had my phone off through the sessions).  On Wednesday, I undoubtedly annoyed some of my fellow train passengers when I received numerous calls asking why stocks and bonds seemed to be reacting negatively to Warsh’s comments.  At one point, the S&P 500 (SPX) was off by more than 1%, which would have made it the third straight decline of that magnitude after a Warsh FOMC presser.  But we dutifully bounced off the lows, and it was more than simply dip-buyers’ catnip.  Warsh switched from talking tough about inflation to actually doing something about it, restoring a key dose of credibility to the central bank. 

Remember, traders react but investors consider.  I had dinner on Wednesday with a friend, a (happily) retired hedge fund manager who expressed a dose of relief about the FOMC’s rate action and Warsh’s messaging.  I agreed, acknowledging that 25 or 50 basis points should not be sufficient to upend a healthy economy if modest hikes help suppress inflation.  The markets seemed to concur as well, certainly by the next morning when stock futures recovered their losses and bond yields fell.  Stocks continued to rally as 10-year yields dropped, with SPX closing 1.1% higher and 10-year yields dropping by 9 basis points from 5.02% to 4.93%. 

The relationship between stocks and bonds was quite solid yesterday but has largely unraveled today.  As I type this, 2-year and 10-year yields are about 7 bp higher, with the latter once again flirting with the key (psychological) 5% level.  At the same time, SPX is down by less than 0.2% while the Nasdaq 100 (NDX) is essentially unchanged.  This is why I referred to the “ratchet effect.”  Stock traders used the positive developments as a reason to rally but didn’t seem to care when those developments turned unfriendly.  Indeed, today we see NYSE decliners outpacing advancers by about 2.5:1 and SPX net decliners leading by about 250.  The selling is a bit more broad-based than it looks.

Two breaking news items have hit markets while I was typing this.  First, we had a big rally in cryptocurrencies on reports that the CFTC will be writing a set of new crypto regulations.  That caused bitcoin to recoup the $80,000 level that it lost when the legislative efforts failed earlier this week.  Second, the yen was in the midst of a steep decline this morning, despite a 25 bp hike from the Bank of Japan.  Most of those losses reversed when the BOJ was said to be doing a “rate check”, a move that can precede an intervention.

Bottom line: the bullish sentiment remains ingrained in the equity markets, even if other key influences are quite a bit more tenuous.