Baker Market Update – wk220429

Stocks are weaker, the dollar is soaring, and bonds continue to range-trade as this week nears an end. The futures market is priced for a near 3% fed funds rate one year from now as policymakers stumble over themselves to telegraph how hawkish they are. Meanwhile, the Bureau of Economic Analysis reported yesterday that the US economy did not grow in the first quarter of this year, but rather it contracted by 1.4%. Many analysts shrugged off the report by pointing to the fact that most of the decline was attributable to net exports and the drawdown of inventories which had previously become bloated. Still, there is a reason that those components feed into the number and it is too early to suggest that these are temporary or one-off factors. The export sector in particular can be expected to suffer additional damage going forward from the strong dollar. Moreover, earnings of overseas operations for US corporations will be negatively impacted by the currency conversion if the greenback maintains its mojo.

There is an argument convincingly made by Dave Rosenberg of Rosenberg Research that we are much closer to recession than commonly thought, and that the Fed is likely to overplay their hand on tightening… something they historically and characteristically tend to do. An asset price bubble fueled by Fed ease and Treasury stimulus over the last two years has reached extremes that will be difficult to sustain much longer in the face of aggressive tightening. Fed Chairman Jerome Powell, singing the praises of his predecessor Paul Volcker, is determined to squash inflation rates that currently exceed 8.5%. That involves demand destruction at a time when real personal income is falling due to the sudden cessation of fiscal stimulus this year. As noted by Rosenberg, Fed tightening cycles are always followed by some sort of crisis. If not recession, a bubble burst of some sort may be on the menu. And if that happens, look for a safe-haven trade into the Treasury market.

The Fed is expected to hike its policy rate by 50 basis points and launch quantitative tightening at next week’s FOMC meeting. We will also see from the labor department how the job market performed in April. Most analysts expect a healthy 375,000 new payrolls were created. Next week will also see the release of manufacturing and trade data as well as construction spending and factory orders.