MAY 8-12, 2023

A volatile week, rising rates, and a softening economy weakened the technical signals. Sowell’s tactical model continues to experience technical instability and rests in a defensive neutral position (60/40).

It was another turbulent week for bank stocks, led by a fall in regional banks as PacWest announced it was considering strategic options inferred by the market as another bailout. The KBW Nasdaq Regional Bank Index lost -7.39% during the week, while the financial sector -2.96%. Ahead of heading into last Wednesday's highly anticipated FOMC meeting, albeit the market has already priced in a quarter-percentage point increase, many pundits narratively would advise Fed Chair Powell to pause. Sheila Bair, former Chair of the FDIC, was recently quoted on CNN as saying, "Hitting pause doesn't mean you're giving up the fight. It just means you're taking a breather and assessing what you've accomplished so far." Although the S&P 500 gained +1.65% the day after Fed Chair Powell raised the benchmark Fed Funds rate by 25 basis points, the S&P 500 for the week declined by -0.78% while the bond market returned -0.05%. Much of the last week's lift was from strong jobs reports and Apple beating on strong sales and profits.

Overall, the economic report was mixed. The good news is the unemployment rate tightened to 3.4%, the job participation rate edged higher to 62.6%, and Private Nonfarm Payrolls reported an increase of 230k, all higher than consensus. However, Factory Orders slowed to 0.9%, U.S. productivity declined by -2.7%, and Consumer Credit rose to $26.5 billion as credit card balances spiked on a slowing economy.

The week ahead will continue to digest the FOMC's narrative heading into Wednesday's key CPI report and a number of other key measures, including Wholesale Inventories and PPI. Headline news will continue to focus on political gridlock over raising the $31 trillion debt ceiling by June 1, according to Treasury Secretary Janet Yellen, challenged by lawmakers seeking budget cuts. All while Bernie Sanders, on the other end, is proposing raising the Federal minimum wage to $17 an hour, furthering the risk of wage inflation – while the Fed is raising rates to combat inflation.

"The economy is likely to face further headwinds from tighter credit conditions. Credit conditions had already been tightening over the past year or so in response to our policy actions and a softer economic outlook. But the strains that emerged in the banking sector in early March appear to result in even tighter credit conditions for households and businesses. In turn, these tighter credit conditions will likely weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain. In light of these uncertain headwinds, along with the monetary policy restraint we have put in place, our future policy actions will depend on how events unfold." – Fed Chair Jerome Powell, FOMC Press Conference, May 4, 2023.

Fed rate final hike or not?

The Federal Reserve decided to raise interest rates again during the recent May meeting, announcing another hike that brought the rate to the previously stated target range of 5-5.25%. While this seems to be a relatively aggressive decision after the series of banking crises, it was not a major surprise as the Fed had already announced its goal in March and had not given any indication of softening its stance before the May meeting. As a result, the rate has been brought to its next peak since 2006 by this 10th increase.

Now with the interest rate having reached its target range, the focus has shifted to what comes next. Is this 10th raise going to be the final hike or not? While the Chairman, Jerome Powell, said, "a decision on a pause was not made today" during the Wednesday news conference, the words in the post-meeting comments have been viewed as a soften signal, as they removed the sentence in the previous meeting comments in March, which says "the Committee anticipates that some additional policy firming may be appropriate." Chairman Powell also responded that it would be too soon to cut rates for now. It gives the public information that the Fed is not trying to have an immediate hike or cut, and unlike in March, they do not have a clear plan for future rate policies yet. It might be the right time for the rate to rest at this high level until further market responses are reviewed.

Regarding the recent banking runs, viewed as a direct or indirect result of the constant interest rate raises, Powell described it as occurring with unexpected speed and commented that additional regulations and supervisions are necessary for the future. It is not surprising that runs can occur at a much more frenzied pace. The digital age has accelerated the dissemination of both news and panic. Then technology has made it much easier for investors to withdraw their money from a bank with just a few clicks online. Even though the Fed was sure to be aware of the increased sensitivity, they could still be surprised by how crazy it can be. Given the current circumstances, they have to analyze market reactions and set up supporting policies before making any further possible hikes, especially any frequent series of rises like what the market has experienced so far. Returning to the question at hand, can this 10th hike be the final one? Possibly, especially in the short run, where the market and Fed need time to adjust everything. Long-term decisions will hinge on how the market reacts to this 10th experiment, but the Fed will need to exercise greater caution to avoid another banking crisis from happening. In the meantime, with persistent inflation pressures and worsening US-China conflict raising the stakes in the globalization-regionalization framework, debate over the Fed target inflation rate of 2% is bound to resurface, clouding the path of future interest rates.

Advisory services offered through Sowell Management, a Registered Investment Advisor. The views expressed represent the opinion of Sowell Management. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and non-proprietary sources that have not been independently verified for accuracy or completeness. While Sowell Management believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Sowell Management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is not indicative of future results.


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