Market Seeks Meaning in Fed’s “Soft Landing” Code
April 22nd, 2022
The Federal Reserve’s hawkish tone on rates stymied what had been an early week advance. On Thursday, Fed Chairman Jerome Powell confirmed that a 50-basis point hike is a given at the FOMC’s meeting next month. He justified the use of the higher-than-normal rate increase as being “absolutely essential” in order to control the inflation that is currently plaguing the economy. His comments followed those of San Francisco Fed President Mary Daly, who during an interview on Wednesday said she supported an “expeditious march” on rates for the remainder of the year, while acknowledging that a mild recession was not out of the question. She softened that statement by saying she felt that such an outcome was unlikely, but the mere fact that a recession is being contemplated concerned some. The Fed’s increasingly hawkish tilt pushed bond rates higher with the 5 and 10-year U.S. treasuries hovering either side of the 3% level by week’s end. Consequently, the S&P 500 fell -2.75% as investors recalibrated their rate expectations, while managing to ignore better than expected Q1 2022 earnings results, neutral housing data and decent GDP figures from China.
Rising Mortgage Rates Cool Housing Volume
The Fed’s rate guidance and its decision to buy fewer mortgage-backed bonds has come to bear on the mortgage market. This week the average 30-year mortgage rate hit a 12-year high of 5.11%. This is a sharp increase from the 2.97% averaged just a year ago, and for would-be homeowners it means that mortgage payments on new loans are effectively 31% higher than an equivalent loan taken out last March. The combination of higher borrowing costs and soaring housing prices is beginning to work its way through the housing markets. March’s existing home sales volume fell -2.70% month-to-month, while sales declined -4.50% year-over-year. Despite the rise in borrowing cost, home buyers are still willing to pay up for homes. The median sales price in March increased 15% year-over-year to a record high of $375,300. Houses are still in high demand, however, with the average home listing sitting on the market for 17 days. A staggering 87% of homes sold in March had been on the market for less than a month. The housing market remains extremely tight, but homebuyers may soon have more options from which to choose. Inventory rose 11.80% in March, which will likely increase in the months to come.
China’s Economy Accelerates Despite Zero-Covid Strategy
China GDP rose 4.80% in Q1 2022, up from 4.00% in Q4 2021. Growth in fixed asset investment and factory output helped to offset a drop in both retail sales and home sales resulting from Covid isolation mandates affecting millions. Major industrial centers, including Shanghai and the northeastern industrial province of Jilin, were part of China’s lockdown. As of Monday, an estimated forty-five Chinese cities with a combined 373 million people were in either full or partial lockdown. That was a sharp increase from 23 cities and 193 million people a week earlier. The 45 cities account for more than one-quarter of China’s population and roughly 40% of the country’s total economic output. Despite China’s zero-Covid strategy, businesses are adapting to the situation. Many have adapted by operating under a “closed loop management” system. Under the system employees live on site and are subjected to daily testing. China appears committed to its zero-Covid approach with some regions such as Shanghai now in their fifth week of lockdown. The containment policy has exacerbated supply chain problems, and while global manufacturers may anxiously await its rollback, that comes with its own cost as inflation is likely to tick higher with the release of China’s domestic pent-up demand.
This week’s earnings reports were generally well received by investors. With 99 companies in the S&P 500 having now reported earnings, 77.80% have managed to beat analyst estimates. That is well ahead of the 66% long-term average beat rate, and with the addition of this week’s data, it now appears that Q1’s earnings growth will come in at +7.30%. This is significantly better than the 6.40% projected earlier in the quarter. All this should have been music to investor’s ears, but markets are forward looking, and this is where the Fed looms large. The Fed oversees an economy that steers like an ocean liner traveling at high speed. It can’t turn it all at once or it risks capsizing and what we’ve seen over the past several week’s is a Fed trying to incrementally move the market to its way of thinking. At the beginning of the year, the Fed began conditioning the market that it would raise rates and to do so with as many as seven rate hikes in 2022, commencing in March. Having done that, it then followed through with its 25-bps hike in March and then started messaging larger rate hikes in May and June. Powell just cemented that on Thursday and then came the whispers of a potential 75 bps hike and the Fed’s belief that a worst-case downside for the economy is a “mild recession”. Any time the Fed raises rates, the probability of a recession increases because, de facto, the goal in raising rates is to reduce demand and cool prices. That is just the reality of it all, but the market is now acutely conditioned to anticipating where the Fed’s comments lead. With the Fed speaking to recession risk and then qualifying any such recession as being potentially “mild”, it then begs the question if that has not now become the Fed’s acceptable definition of a “soft landing”. It may just be that the Fed is being honest, but it gave markets something new to consider this week.
The Week Ahead
The early January Omicron wave is expected to weigh on U.S. economic growth. The Atlanta Fed is currently forecasting Q1 GDP of 1.30%, a sharp slowdown from Q4’s 6.90% rate. However, the Q1 GDP print could be the low for the year as a strong jobs market and wage gains could provide a strong floor for consumer spending. We’ll see if that’s the case as March personal income and consumer spending figures are released next week.
Are We Having Fun Yet?
There is no hard science behind it, but endurance athletes and outdoor adventurers have been discussing a “fun scale” for years – unbeknownst to most of us who have been living our lives assuming fun was binary, either you are having it or you aren’t. Dinner with friends, listening to your favorite music, and watching a sunset are examples of Type I fun on the fun scale. Running a 100-mile race is not fun for the majority of people, but it’s an example of Type II fun sought out by adventure seekers. It is challenging and hard but generally won’t kill you.
The fun scale is reported to have been coined in 1985 by Rainer Newberry, a geology professor at the University of Alaska. It became a common term among rock climbers who used the scale to define rock climbing routes.
Type I fun is enjoyable from the beginning, such as eating ice cream or reading a good book. It is fun to do and fun to remember. Type I fun keeps us in our comfort zone. The physical investment of time and effort is pretty low.
Type II fun is something that is hard in the moment where you might think to yourself “why am I doing this?” but in retrospect you are glad you did. That is why it is also called “latent” fun. It can be difficult but it provides a sense of accomplishment. Type II experiences push us out of our comfort zones, which can make them much more memorable than Type I. Type II fun is what propels individuals to climb mountains, run marathons, and engage in other grueling activities that might be miserable while you are doing it, but upon completion and then reflection, they are remembered fondly and have you yearning for more. Some argue that Type II fun provides greater fulfillment than Type I because it is more exciting and makes us better, stronger versions of ourselves, allowing us to embrace discomfort, problem solve, and come out on top. The old saying “what doesn’t kill you makes you stronger” is true here.
Type III fun involves fear and danger. It could start out as Type II fun, such as a difficult mountain bike ride, but then turn into Type III with a severe storm that makes the trails slick and dangerous, which isn’t fun at all. Or, it could be getting dangerously lost on a hike in the woods and having to spend the night in the wilderness without any shelter. Having a Type III fun experience can cause you to never do that type of activity again. Some people would wonder why Type III is even called fun at all, and the only redeeming quality of a Type III experience is that it provides a good story to tell as long as you survive. And there is fun in that.
Science shows that going through periods of stress and dealing with it, which happens in Type II and Type III fun, helps cultivate a growth mindset which is why endurance athletes learn to see stressors as challenges rather than threats. They test their limits and regularly overcome obstacles when things don’t go as planned. It helps that the human mind is extremely resilient and has an amazing capacity to forget pain and suffering. Call it selective memory, but for most people, Type II and Type III fun are only fun in hindsight.
Whatever type of fun you seek, we hope you have a wonderful, fun-filled weekend.