- Fed’s semi-annual financial stability report provides a clear asset price warning
- U.S. payroll report expected to show sharp job gain, although there is still a long way to go
Fed’s semi-annual financial stability report provides a clear asset price warning — The Fed provided a clear warning about stock prices and frothy risk areas such as SPACs, meme stocks, and cryptocurrencies in its semi-annual financial stability report released after the stock market closed Thursday afternoon.
Fed Governor Lael Brainard, in a statement released with the report, said, “Vulnerabilities associated with elevated risk appetite are rising. The combination of stretched valuations with very high levels of corporate indebtedness bear watching because of the potential to amplify the effects of a re-pricing event.” A “re-pricing event” in non-Fed language is otherwise known as a stock market crash.
The Fed report said that valuations for some assets are “elevated relative to historical norms even when using measures that account for Treasury yields. In this setting, asset prices may be vulnerable to significant declines should risk appetite fall.”
Fed Chair Powell said himself at his April FOMC post-meeting press conference that some parts of the markets “are a bit frothy, and that’s a fact.” Dallas Fed President Kaplan on April 30 said, “We’re now at the point where I’m observing excesses and imbalances in financial markets. I’m very attentive to that, and that’s why I do think at the earliest opportunity I think it will be appropriate for us to start talking about adjusting those purchases.”
Mr. Kaplan yesterday repeated his call for discussions on QE tapering, saying that he would like those discussions to begin “sooner rather than later.” He said the economy would be “much healthier” if the Fed were to start “weaning off these purchases.”
A recent survey by Bloomberg found that 14% of the analysts surveyed expect the Fed to start tapering its QE program in Q3, and 45% of the analysts expect tapering to begin in Q4. Opportunities for the Fed to announce the tapering could come as soon as the July or September FOMC meetings or at the Fed’s late-August Jackson Hole conference. The consensus is for the tapering to last 7-12 months.
However, the market is still not expecting the Fed to start raising rates until early 2023. The Bloomberg survey found a consensus for two +25 bp rate hikes in 2023 that would bring the funds rate target up to 0.50%/0.75% from the current level of 0%-0.25%.
The stock market is clearly on watch for any events that could spark a sharp sell-off since there have recently been some unexplained stock market drops. The majority of Fed officials have been dovish and have been trying to reassure the markets that a rate hike is a long way off. However, if inflation should start to show a sharp and persistent rise, then the Fed would have no choice but to start QE tapering and lean towards a rate hike. That could easily spark a sharp sell-off in stocks as the punch bowl is taken away sooner than expected.
The markets also remain worried about the possibility of another hedge fund blowup. The Fed’s financial stability report noted that “available data suggest” hedge funds are highly leveraged and there is a need for more risk transparency.
Ms. Brainard, in her statement yesterday, said that the recent blowup of Archegos Capital Management “illustrates the limited visibility into hedge fund exposures and serves as a reminder that available measures of hedge fund leverage may not be capturing important risks. The potential for material distress at hedge funds to affect broader financial conditions underscores the importance of more granular, higher-frequency disclosures.”
U.S. payroll report expected to show sharp job gain, although there is still a long way to go — The consensus is for today’s April payroll report to show a sharp increase of +995,000. Payroll growth was modest at +233,000 in January, but then rose to +468,000 in February and surged by +916,000 in March, producing a 3-month average monthly gain of +692,000.
Job growth is picking up quickly now that the pandemic is fading and more businesses are reopening. Restaurants, retail stores, and travel are making a come-back and are hiring. Still, payrolls need to rise by another 8.4 million jobs to get back to the record high seen in February 2020 before the pandemic devastated the labor market.
Wednesday’s April ADP jobs report showed a +742,000 rise, which was encouraging although weaker than the consensus of +860,000. ADP jobs in the first four months of this year have shown a monthly average increase of +421,000.
The consensus is for today’s April unemployment rate to fall by -0.3 points to 5.7%, which would be a 13-month low. A recent survey by Bloomberg found that the markets are expecting the Fed to start tapering when the unemployment rate has fallen to around 4.5%, which is about half-way between today’s expected level of 5.7% and the record low of 3.5% seen in late-2019 and in February 2020.
Further declines in the unemployment rate are likely to be more grudging because more people will be coming back into the labor market as jobs reappear. As more people come back into the labor force, it will take more jobs to produce the same percentage-point decline in the unemployment rate.
