Tariffs Announced, Stocks Crash, Bond Yields Drop, Risk Spreads Widen: Is the ‘Fed Put’ in Play?
Wednesday’s announcement of a long-telegraphed sweeping set of baseline tariffs on virtually all U.S. trading partners sent capital markets into a tailspin. Equity markets crashed. U.S. stock markets have lost $6.6 trillion over the past 2 trading days (yesterday and today). The largest 2-day loss on record. Treasury yields plummeted to their lowest levels since early October on a flight to quality. The 10-year Treasury was 4.22% Wednesday afternoon, dived to 3.87% early today, and then settled at 4.00%. Spreads: Lender trading desks were not anticipating the level of volatility Thursday and Friday. CMBS, Life Companies, Freddie Mac: The general sentiment is that they are honoring executed loan applications, as they include floor rates that are agnostic of the spread (as one originator said: ‘This is why we put the floor in the app’). Immediate reaction seems to be that fixed-rate risk spreads widened 10-20 bps (or more) over the past 48 hours. Many lenders indicated that the trading desks will provide more “clarity” on Monday. Corporate Bonds: High-yield corporate bond spreads over Treasuries spiked from 342 bps to 401 bps, while investment grade rose from 96 bps to 106 bps. (High yield spreads are still relatively ‘tight,’ as they hit 1,000 bps during the COVID panic of 2020 and 2,100 during the 2008 crisis). Volatility is up as the VIX index hit 45.3 (it was 17 on March 24; the 2008 peak was 44, and the COVID peak was 54).
Source: Wall Street Journal
What’s next? What about the ‘Fed put’? Near-term scenarios from the tariff implementations include: (1) Slow growth, higher prices, employment ‘flatlines’ (stagflation; the Fed may be cautious to overreact); (2) Higher prices and job losses (the Fed is torn between their dual mandates of maximum employment and stable prices). The 2022 statements from Powell referring to rising inflation as ‘transitory’ may come back to haunt him as he weighs acting too quickly—dropping rates on growth concerns and spiking inflation vs. waiting too long (holding rates higher while the economy drifts into recession). (3) Or, possible negotiations with various trading partners result in bilateral easing of the upcoming tariffs, putting downward pressure on volatility (note that Vietnam and Argentina are possibly negotiating with the USA as of today).
Powell today: “Our obligation is to keep longer-term inflation expectations well anchored and to make certain that a one-time increase in the price level does not become an ongoing inflation problem. We are well positioned to wait for greater clarity before considering any adjustments to our policy stance. It is too soon to say what will be the appropriate path for monetary policy.”
What about the data? Last week’s PCE report showed persistently ‘sticky’ inflation, as the core annual inflation rate hit 2.8% (vs 2.7% expected) and 0.4% monthly (0.3% expected). Watch out for the next consumer spending reports (consumer spending is 65% of GDP). Today’s jobs report release indicated another month of relatively strong job growth in March (228,000 jobs created) and a higher-than-expected 4.2% unemployment rate (not alarming). But government layoffs are not yet factored in, as many are on ‘paid leave’ or in other technically employed statuses. We expect to see those numbers spike in next month’s report.
Consumer: Recent stats show a ‘tiered’ or ‘K-shaped’ spending profile – the top 5% of earners account for over 50% of spending. They may be inclined to pull back as stock market portfolios lose value. That, combined with average consumers saddled with increasing credit card and other consumer debt, could lead to a significant pullback in spending. That may push the Fed towards cutting. High-profile analysts are divided. Some are now predicting as many as 4 rate cuts this year, while others are predicting no rate cuts due to tariff-induced price increases. Futures markets show a 33% chance of a 25 bp cut at the May 7 meeting (up from 18% last week) and a 94% chance of at least one cut by June 18. For the year, there is a 37% chance of 4 cuts. The so-called neutral rate is still pegged at 3.00% according to most economists, so 4 cuts would put it near that rate.
What else? Lower-than-expected tax receipts have contributed to a low treasury balance (see chart), which is putting the ‘X date’ for the debt ceiling as early as late May (it was thought to be July/August just last month). The House and Senate bills include debt ceiling increases of $4T and $5T, respectively (that’s intended to get us to the midterm elections in November 2026). For now, the world will be watching Washington over the weekend for any clues as to possible adjustments, negotiations, or digging in for the long haul. Stay tuned…
By David R. Pascale, Jr., Senior Vice President at George Smith Partners.
