Fed Moves Markets, But In Wrong Direction
By Scott Poore, AIF, AWMA, APMA
Chief Investment Officer, Eudaimonia Group
We've got an action-packed, if not strange, musings this week. The long-awaited "pause" in rate hikes by the Fed was met with a rather large "thump." Economic data is all over the place. And, if that weren't enough, there was more regional banking drama this week. These strange days remind me of two things - vampires and The Doors. 
- One of the songs in the film, "People Are Strange," was originally recorded by The Doors. The cave in the film where the vampires live has a poster of Jim Morrison (lead singer of The Doors). The version of the song used in the film was recorded by Echo & The Bunnymen. The movie felt like they could have used a lot more of The Doors music, which has an unusual sound.
- This movie was filmed in an amazingly short time frame - just 21 days. Several thousand local residents were used in scenes involving extras and crowds.
- The actual town of Santa Cruz, where the film takes place, was once plagued in 1970s as the "Murder Capital of the World" for 28 brutal murders that took place over a 30-month period between 1970and 1973.
- Some of the film's scenes take place on the boardwalk of Santa Cruz. Every year at the landmark Santa Cruz Beach Boardwalk this movie is shown as part of the park's free Summer movie series.
Here's what we've seen so far this week...
Pause In June? The Fed raised rates by 25 basis points on Wednesday, as broadly expected. The official statement from the Fed was similar to how they concluded interest rate increases in 2006. 
The statement also made reference to "tighter credit conditions" due to the banking crisis. The key element for future potential hikes was removal of language saying "some additional policy firming" meaning a pause is likely at the next meeting in June. However, this pause is being labeled a "hawkish pause" as it does leave the door open for one more rate hike if needed. The market, so far, has not been enthused with the news of a rate pause. Earlier in the week, JP Morgan analysts had speculated that the announcement of one more rate hike and pause would lead to a rise in equities around 1%. 
That has not been the case, as markets are lower by approximately 2% before today's action. One has to wonder, why the lack of enthusiasm? Well, for starters, fears over the banking crisis were renewed this week when First Republic went into failure and assets were purchased by JP Morgan. Then, PacWest Bank (PACW) indicated in a statement that it was exploring its "strategic options" that could include a potential sale. 
Rumors then swirled around Western Alliance Bancorporation (WAL), another regional bank, that it was looking for a bank to purchase its assets. Western Alliance has refuted those rumors and stated their deposits actually improved last week. If that weren't enough, First Horizon (formerly First Tennessee Bank) shared the news that its planned $13.4 billion merger with TD Bank that the two have been working towards for the last 14 months was being terminated for "unspecified regulatory issues." Both banks assured investors that they had not seen notable changes to outflows and have "stable funding." 
As a result, the Dow Jones Regional Bank Index is down approximately 46% from pre-Banking Crisis highs. While it is likely too early to dip a toe into regional bank stocks, some of the data actually improved this week. Money Market Flows, which showed a considerable uptick last week, declined this week. This indicates that the "fear" trade may not be as bad as advertised. Usage of the Fed's Discount Window dropped last week to pre-Banking Crisis levels. Access to the Fed's Bank Term Funding Program (BTFP) declined last week, but remains elevated. This is good news overall with regard to the banking situation, but we're not out of the woods yet. Ideally, we would like to see a sustained low level of Discount Window usage and a substantial decline in BTFP funds.
Break Or Break Through? Investors could be questioning the "hawkish pause" and whether or not the Fed has broken something. 
In all honesty, we're asking the same question. However, there are certainly some data points that suggest this is not yet the beginning of a recession. The Jobs Report came out this morning and showed more jobs created than were expected. Economists had expected 180,000 new jobs, yet April's number was 253,000 (73,000 higher than expected). Private ADP Payrolls also showed significant hiring in April of +296,000 jobs (double the amount expected). 
While this doesn't mean the end of good times right away, if history follows, it could mean lower returns at some point moving forward. As of this morning, both the VIX and the TED Spread are trading below both their 50-day and 200-day moving averages. We take this to mean that a bear market is not imminent. However, given some of the historical data, it does mean we need to be vigilant in watching the data carefully moving forward.
Is The Dollar Going Away? There has been a lot of speculation about the U.S. dollar going away or no longer being considered the world's "reserve currency." While that could be a threat in the future, we do not see that as a realistic possibility in the near term. Currencies fluctuate over time in relation to other world currencies. There are currently 164 world currencies in active use. 
Of those, the U.S. dollar is the world's most-traded currency with about 47% share of all global payments and 87% of FOREX daily turnover. In addition, the world's Central Banks have about 59% of their reserves in U.S. dollars. In other words, the world's banks choose to keep almost two-thirds of their "savings" in U.S. dollars. This is what the definition of "reserve currency" truly means. Lately, articles have been written about the dollar going away in lieu of a "digital" dollar and the petrodollar waivering. While these are potential risks to the dollar's reign as a global standard, they are hardly on the horizon. 
First, the announcement of FedNow incurred speculation of a domestic "digital dollar." However, FedNow is not a currency, often referred to as a CBDC (Central Bank Digital Currency). FedNow is simply a new payment service to facilitate digital currency transactions. It's an attempt for the Fed to provide some kind of regulation on an industry that is susceptible to corruption. Congress has not passed a law authorizing the Fed to issue a CBDC, as Congress holds the "power of the purse" and until then, worry over a CBDC in the U.S. is premature. Second, a meeting was held in late March between Chinese President Xi and Russian President Putin. Both leaders seek to position themselves as leaders of a new "multipolar world order." Such an alliance is seen as a threat to the petrodollar - an agreement that has been in place for over 50 years. In the 1970s, the U.S. provided economic aid to Saudi Arabia in exchange for assurances the country would always price its crude exports exclusively in U.S. dollars. While the petrodollar is not a real currency, the decline of U.S. dollars in pricing oil exports could, in fact, weaken the dollar relative to other world currencies used to price oil exports. In reality, when the Fed pauses and/or cuts rates, the dollar tends to slide - and, that is the period we are likely entering now, rather than a new digital dollar or the end of the petrodollar.
Times are certainly strange and it makes one want to scratch one's head in disbelief. As the song suggests, "People are strange, when you're a stranger." Jim Morrison wrote the lyrics because he was depressed and feeling alienated. That's a sentiment that's easy to relate to these days. However, the economy is growing as of this moment and the prospect of interest rates going no higher and inflation slowly subsiding provides some hope. It might be best to leave this week's close to our musings with one of the best endings to a movie in the immortal words of Grandpa...
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