Two points about today’s dreadful market action:
#1: The hotter-than-expected CPI report (headline +7.5 percent) caused a major rethink in the Fed Funds Futures market about the likeliest path of rate policy this year:
- The odds of a 50 basis point hike in March rose from 24 percent yesterday to 85 pct today. Reminder: the Fed has not raised rates by 50 basis points at one meeting since May 2000, and that was at the end of a rate cycle. The Fed has not started a rate cycle with a 50 bp move since at least 1990.
- The June 2022 contract (which covers the next 3 FOMC meetings) now prices in 90 percent odds that rates will be at least 100 basis points higher than today, up from just 34 pct yesterday. The highest odds (53 percent probability) go to Fed Funds at 100 – 125 basis points, with the second highest (32 percent) going to rates at 125 – 150 bps. The latter implies some real possibility of 2 50 bp rate hikes over the next 3 meetings.
- The December 2022 contract now puts the highest odds on Fed Funds being either 175 – 200 basis points at year end (33 percent probability) or 200 – 225 bp (25 pct). Yesterday, the odds of those outcomes were just 17 and 4 percent respectively. These new highest-probability outcomes imply either 7 hikes (one at each remaining FOMC meeting this year) of 25 basis points or at least one 50 bp hike (likely in March, as noted above).
Takeaway (1): the worst-case scenario for stocks from here is that, even at current levels, Fed Funds Futures are still not pricing in the sort of rate increases we had as recently as 1994 – early 1995. That was the last time the Fed aggressively shifted from a post-recession low-rate posture to one intent on normalizing rates and containing inflation. Back then, the FOMC raised Fed Funds from 3.0 percent to 5.5 percent (250 basis points) in 12 months. Even with the recent change in Fed Funds Futures prices, they still only price in meaningful probabilities of 150 – 225 basis points.
Takeaway (2): there’s been some chatter about the Fed doing a surprise rate increase before the official March 16th FOMC meeting. We have no edge on that (and neither does anyone else) … But we’d note that inter-meeting rate decisions are rare, only done during crisis periods, and to the best of our recollection only used to cut rates – never to raise them. We put very low odds of a rate decision before March 16th.
#2: Since we closed very near the lows on the S&P 500 today, we want to remind you of some key levels where history says it is OK to start buying if the selloff accelerates in coming days:
- The key VIX levels to watch are 28, 36, 44, and 52. Those are 1 – 4 standard deviations (8 points) from the VIX’s long run mean. We closed at 24 today, which is most definitely not a “Buy” signal.
- Here are a few VIX levels that have worked in the past year as markers of a near-term market bottom that generally follow the statistics noted above: 29 (February – March 2021), 28 (May 2021), 31 (December 2021), and 32 (January 2022).
- If we get a down 5 percent day, wait for the next down 5 percent day and start nibbling at that one. There were 4 in quick succession in March 2020, and they do tend to travel in packs (2008 – 2009 had more than 10) … A 5 percent one-day decline is a 5 standard deviation move for the S&P 500 and therefore indicates genuine panic.
Takeaway: US stocks are in a tough spot here and, since correlations always go to 1.0 in a selloff, so are global equities. The old trader’s adage “too late to sell, too early to buy” feels about right, at least for long term investors. That said, there will be good opportunities to make money in the coming weeks and months. It will not feel comfortable buying a +30 VIX or a second/third/fourth down 5 percent day, but we don’t trade the market we want; we trade the market we are given.