Views From the Floor – What Markets Are Saying About the Fed…

Do markets have faith in the Fed?; the risk of another Gamestop; and the gap between job openings and people to fill them grows.

What Markets Are Saying About the Fed…

Markets are expecting the Federal Reserve to continue increasing rates, with futures prices now implying more than eight rate hikes by March 2023 (Figure 1).1

However, they also are betting that Fed Chair Jerome Powell reverses course promptly. The Eurodollar curve is simultaneously pricing in not only the hikes, but also a series of four 25-basis point cuts to be enacted by 2025! This was not the case in January, when no cuts were priced into the curve.

One reasonable explanation for markets to price in the Fed raising – and then lowering – rates is that the initial rate increases cause a recession, which would require a loosening of monetary policy. If pricing indicates an overshoot and retrenchment, it means that the Fed would have failed to select the interest rate path which brings inflation under control and stable growth, without causing a recession. The Fed describes its own mandate as maximum employment, stable prices and moderate longterm interest rates2 – the former of which is incompatible with a recessionary outcome. If a rate cut is necessary immediately after rate hikes, then on its own terms, the Fed will have overcorrected.

Figure 1. 3-Month Eurodollar Curve – 4 January, 4 March, 11 April 2022

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Source: Bloomberg; as of 6 April 2022.

Shorting, the Equity Rally and the Next Gamestop

In response to a volatile macro environment in the first quarter, there have been claims that hedge funds reduced their gross and net exposures. Indeed, it does appear that a significant amount of shorting activity happened in the first quarter: our utilisation factor, which shows overall short interest, increased from 10.9 to 13 and 3.7 to 4.8 on an equal-weighted and cap-weighted basis, respectively, in the first three months of the year (Figure 2).

While shorting increased over the quarter, we nevertheless saw a sizeable rally in the latter half of March. The S&P 500 Index surged 11% between 8 March and 30 March, its biggest 15-day percentage gain since June 2020, led by large-cap Growth names that had sold off earlier in the year.3

It is too early to say whether shorting itself is contributing to volatility; we haven’t seen evidence of short covering so far. But it has been a volatile quarter, and if hedge funds continue to batten down the hatches, we may begin to see the sharp price spikes traditionally associated with short covering. After 2021’s Gamestop rally, we don’t necessarily need another reminder of just how bad a short squeeze can get.

Figure 2. Cap- and Equal-Weighted Utilisation

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Source: Man Numeric; as of 31 March 2022.

They Won’t Take Our Jobs!

The US employment gap has continued to expand. Job openings stood at 11.2 million as of February 2022, the most recent data point. However, only 5.9 million Americans were actively looking for work at the start of March (Figure 3). This makes the current labour market the tightest since the Federal Reserve began collecting job openings data in 2000, and the tightest post-war job market if job openings are extrapolated back in time.4

While job openings have hovered between 10.5 and 11.5 million since July 2021, the number of unemployed people has fallen by roughly a third over the same period. In a rational job market, the best-qualified candidates should be hired first. A reasonable assumption would therefore be that with a dwindling pool of well-qualified candidates, firms will have to raise wages to compete for talent. In our view, the growing gap between openings and unemployed workers can only contribute to wage growth.

Figure 3. US Job Openings Versus Seasonally Adjusted Unemployment Level

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Source: Federal Reserve Bank of St Louis; as of 6 April 2022.

With contribution from: Gilles Gharios (Man GLG, Head of Investment Risk) and Dan Taylor (Man Numeric, CIO)

 

1. https://www.cnbc.com/2022/03/16/federal-reserve-meeting.html
2. https://www.federalreserve.gov/monetarypolicy/monetary-policy-what-are-its-goals-how-does-it-work.htm
3. Source: Reuters
4. This extrapolation is performed using the newspaper ‘help-wanted’ index based on methodology by Regis Barnichon of the Federal reserve Bank of San Francisco. Further details can be found here: https://www.sciencedirect.com/science/article/abs/pii/S0165176510002934?via%3Dihub