April 4. Markets to test Powell
–As mentioned yesterday, the 50% retracement in SPX from the post-election low to the high of 2871 in January is 2431. That target, if reached, represents a 15% decline from the high. The question is, how much pain does the market have to inflict before it’s considered a true test of Powell? The Senate confirmed Greenspan as Fed chair on August 11, 1987. Two months later we had the crash. Powell’s speech on Friday takes on increased significance in terms of its effect on risk assets. It’s what we might call a ‘pop-quiz’.
–The press is generally attributing this morning’s weakness to China’s tariff response. But in a bearish market, negative news looms just a little bit larger. So stories referencing a decline in Manhattan real estate as ‘buyers walk away’ or mall vacancies at 6 year highs, aren’t shrugged off as easily. Of interest yesterday was Brainard’s speech on Financial Stability. Why now? Speech was quite interesting and comprehensive, except I thought it was light on risks related to non-US weaknesses in the financial system. The first part served mainly as a warning and acknowledgment that many asset prices are elevated. “Valuations in a broad set of markets appear elevated relative to historical norms, even after taking into account recent movements.” However, protection to the system comes mostly in the form of a capital buffer, which is deemed robust in the US. But there’s also concern about using treasury yields as a benchmark: “In the assessment of elevated asset valuations, the relatively low level of Treasury yields is a mitigating factor; many asset valuation metrics, such as price-to-earnings ratios, corporate bond yields, and property capitalization rates, appear notably less stretched when judged relative to low Treasury yields. That said, Treasury yields reflect historically low term premiums–the compensation investors demand to hold assets over a longer horizon. This poses the risk that term premiums could rise sharply–for instance, if investor perceptions of inflation risks increased.” One other Fed note is that SF Fed’s Williams was named to take over the NY Fed. The NY Fed always is on the FOMC, and obviously is more closely intertwined with markets. Bloomberg notes that Williams is long on academics, short on markets, another little exposed chink in the armor that may be tested.
–Green euro$ pack closed -5 yesterday as stocks rebounded. But this morning that deficit has not been retraced even as stocks see renewed selling. Interesting trade yesterday was a buy of 50k EDM8 9787/9812c 1×2 vs sale of 0EM 9787c for 0.25. In turbulent (equity) markets, the front would be expected to outperform. But tighter funding markets could also result. EDM8/EDM9 closed 37.5, so there’s plenty of cushion. For now.
–Today’s news includes ADP, non-Mfg ISM and Factory Orders.
Link to Brainard speech:
https://www.federalreserve.gov/newsevents/speech/brainard20180403a.htm
