Morning Report: Awaiting the Fed

Vital Statistics:

Stocks are higher as we await the FOMC decision. Bonds and MBS are up.

The FOMC decision is due at 2:00 pm today. Investors will be looking for language that suggests a pause in rate hikes. We are seeing more Fed officials call for a pause given the First Republic situation. The Fed Funds futures are overwhelmingly predicting 25 basis points today, but the June futures are now assigning a below 10% chance of another 25. Late last week, that number was about 25%.

Larry Summers was interviewed on Bloomberg TV yesterday, and the interviewer asked about reports that up to half of US banks would have negative equity if everything was marked to market. I personally have not seen such reports, but that is a remarkable statistic if true.

Larry’s answer didn’t push back against that claim, however he called it somewhat alarmist because it didn’t take into account that many banks have deposit rates below the interest rate earned on these Treasuries and MBS assets, so they are earning a spread and that below-market rate deposits could be considered asset-like. Of course the problem with that theory is that the bank isn’t in control of that asset. It doesn’t get to determine whether it stays on the balance sheet – the depositor does.

Ultimately, we are talking about Treasuries and MBS and these assets are money good. Now commercial real estate (especially office) is struggling and that could dent the banks.

The economy added 296,000 jobs in April, according to the ADP Employment Report. This was well above expectations and is higher than the forecast for Friday’s jobs report. Pay gains overall rose 6.7%, although the pace of gains is moderating. Job changers saw an increase of 13.2%, a percentage point lower than the previous month and the lowest level since November 2021.

“The slowdown in pay growth gives the clearest signal of what’s going on in the labor market right now,” said Nela Richardson, chief economist, ADP. Employers are hiring aggressively while holding pay gains in check as workers come off the sidelines. Our data also shows fewer people are switching jobs.”

Manufacturing jobs fell, as did professional and business services. Leisure and hospitality accounted for over half the job gains.

Between the banking situation and the inflation situation, the Fed is in a bind. The surest way to fix the banking system is to lower rates, while the inflation situation is not fixed yet. The easiest path is probably to pause and wait to see how things shake out.

The services economy improved in April, according to the ISM Services Index. Employment decelerated, while new orders increased. Prices advanced as well. “There has been a slight uptick in the rate of growth for the services sector, due mostly to the increase in new orders and ongoing improvements in both capacity and supply logistics. The majority of respondents are mostly positive about business conditions; however, some respondents are wary of potential headwinds associated with inflation and an economic slowdown.”

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