After yesterday’s big losses, stocks should be bouncing back this morning.
But they’re only dropping further after Fed Chairman Jerome Powell’s lackluster remarks on rates.
“Fed Chair Powell had the opportunity to put to rest concerns he is losing control of the yield curve,” wrote Rabobank’s Michael Every.
“He didn’t.”
Rising Treasury yields are leading the market lower as a result. On Wall Street, banks have been begging the Fed to change its tune.
“How long can this last?” asked JPMorgan analysts.
“Look toward the Fed’s Mar 17 meeting where we may see Powell use his words a bit more judiciously. That said, unless he sees funding markets start to seize or the housing market stall, it seems unlikely that the Fed will change its behavior.”
A March 17th press conference following the next FOMC meeting could set the tone for stocks heading into April. It’s doubly critical because of an approaching supplemental liquidity ratio (SLR) deadline.
Back on April 1, 2020, the Fed announced a temporary change to the SLR rules, which allowed banks to hold far more “no-risk” securities (like Treasurys) without having to include them in their total debt calculations.
Once the change in SLR requirements occurred, banks then massively expanded their leverage. It was timed perfectly as the Fed also initiated a $3 trillion “blast” of quantitative easing, enabling banks to gather even more in bonds and deposits than they normally would have.
Analysts estimate that the SLR adjustments reduced bank capital demands by $55 billion while generating an additional $1 trillion in Treasury activity.
That resulted in sinking Treasury yields as Treasury prices shot higher. Growth stocks (mostly tech in this case) loved the low rates, as companies that chase aggressive growth typically need cheap debt to do it.
The SLR change worked out beautifully for bulls because of this. But on March 31, that temporary adjustment will expire.
If the Fed doesn’t extend the rule change, the Treasury market will get hammered in a massive wave of selling. Bulls hoped that Powell would say something about keeping the SLR relief going through April, but in yesterday’s comments, he made no such promise.
Yields spiked in response. It’s the responsible thing to do, of course, and Powell should be applauded for his efforts to reign-in several out-of-control markets.
As usual, though, neither stocks nor Treasurys will be able to handle the reality check. Major sell-offs will follow in both markets if the FOMC doesn’t announce an extension on March 17th.
And the way it’s currently going, it doesn’t seem like anyone in the government wants the SLR grace period to continue, either. Senators Elizabeth Warren and Sherrod Brown sent a letter to the Fed and FDIC (Federal Deposit Insurance Corp.) suggesting that granting such an extension would be a “grave error.”
The FDIC Chair, Jelena McWilliams, seemed to agree with Warren and Brown. When asked why she doesn’t support another SLR exemption, she deferred to the Fed’s better judgment.
“That’s because capital requirements for the parent holding company, which is regulated by the Fed, are more important for determining how expensive it is for those banks to hold Treasurys,” McWilliams explained.
So, it doesn’t look like there are too many folks in Washington on “team SLR extension.” That could bode very poorly for bulls if Powell and the FOMC heed their advice.
Keep in mind that sentiment will turn on a dime if the Fed decides to control rates, but until any official announcement is made, bearish pressure should continue to snowball.
Leading to a correction that pulls the market beneath its January lows, en route to a full-blown bearish reversal.
