About that big Fed pivot . . . 

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Good morning. Earnings reports start rolling in fast this week – big tech, big oil, big retail, and so on. Will we be feeling better or worse about the economy and the market after we get the news? Better, we think, but we are open to other views: robert.armstrong@ft.com and ethan.wu@ft.com.

The rates picture changes. A little.

One line we’ve often repeated around these parts is that the bond market reflects confidence that high inflation will last a year or two, at most, before subsiding. That confidence is starting to waver a bit. With investors spooked by a hawkish Federal Reserve (perhaps too soon, in our view), the entire yield curve has moved up over the past month:

As you can see above, the biggest bulge is toward the middle of the curve whilst the longer end has only risen a touch (a friend called it the “anaconda curve”). This is showing up in the 10-2 bond yield spread, which is at its lowest level since October 2020:

Although the 10-2 spread is at a year-plus low, inflation break-evens, having spiked late last year, are closer to their November levels:

A rising, flattening yield curve alongside calm break-evens tells a clear story, one increasingly popular on Wall Street. It is that a tightening Fed will either overshoot and slow the economy, or will successfully rein in inflation as supply and demand conditions gently normalize.

Here is Michael Pond and Jonathan Hill of Barclays making that case:

We believe that the more concerned the Fed becomes, the less markets should worry about persistent under- or overshoots.

Therefore, even as current inflation pressures remain elevated, we expect markets to price that either inflation will come down on its own as (both demand and supply side) pandemic-driven high inflation fades, or it will come down as the Fed errs on the side of tightening policy too fast, risking declining asset prices and an economic slowdown.

Another interpretation is that the Tips market is illiquid, distorted and generally full of crap. Break-evens are the difference between plain Treasury yields and the yield on Tips, or inflation-protected Treasuries. And Tips have lately been climbing. After averaging -0.85 per cent since April 2020, today’s 10-year Tips issuance is offering a -0.54 per cent yield. If Tips are rising for some non-fundamental reason, break-evens might be artificially low.

We do not have a grand verdict. Thinking about rates, as we’ve noted, demands epistemic modesty. But there is another prospect worth considering: that inflation surprises to the downside and the Fed raises rates slowly. Until quite recently, markets have evinced a consistent upward bias in their rate expectations. This pattern could easily repeat itself. The yellow whiskers on this Bank of America chart show market expectations for the fed funds rate versus the actual rate in dark blue:

Fed officials are taking this possibility seriously, even if markets aren’t. Atlanta Fed chief Raphael Bostic said as much in an interview with the FT published over the weekend that many took as a hawkish sign. While Bostic would not rule out a 50 basis point hike in March, nor did he rule out taking things slower (emphasis ours):

“Every option is on the table for every meeting,” Bostic said on Friday. “If the data say that things have evolved in a way that a 50 basis point move is required or [would] be appropriate, then I’m going to lean into that. . . If moving in successive meetings makes sense, I’ll be comfortable with that. . .

He added that he would be watching closely for a deceleration in monthly consumer price gains and further evidence that rising wages are not feeding meaningfully into higher inflation when thinking about his forecast for interest rates. He said he was encouraged by the latest employment cost index (ECI) report, which was published on Friday and tracks wages and benefits paid out by US employers, and expects a moderation in wage growth going forward.

Too many are interpreting “every option is on the table” as foretelling a hawkish Fed. That’s a fair base case, but the risks are two-sided. (Ethan Wu)

Ark’s yard sale

Cathie Wood says innovation is on sale, which is true in a certain sense. The technology ETF she manages is down 56 per cent from its peak about a year ago. But we wondered if this looked more or less true when looking through the fund as a whole and considering its individual constituents. So we ran a screen of the growth and valuation of all the stocks in the fund as of the end of the year (thanks to Tiziana Antonietti of S&P Capital IQ for help setting it up).

The striking thing is that, out of 50 stocks, all but one – Intellia Therapeutics, which develops medicine using Crispr gene-editing technology – is down since last February. It’s just a complete washout, as this chart shows (gold star for identifying the movie reference in the title):

This might inspire some of you to make a joke of the increasingly popular LOL @ Ark sort. That’s not our response. This chart suggests to us that the recent selling in these tech long-shots has been as indiscriminate as the buying was back in 2020. So there may just be some mispricing hidden in here.

Whatever else might be true of the companies in the fund, they are growing fast. Here is annual revenue growth for those that have revenues (a handful do not). The last five on the left have low revenues that are growing so fast it threw the whole chart off to include it, so we cut the tops off:

Stockpicking is hard. But we have reached the point in the long-shot tech sell-off that stockpickers with a taste for growth should be licking their chops. This is a little weird, given how little the rest of the market has corrected, but there it is.

A few examples of Ark companies that most people will have heard of: Zoom grew its revenues by 35 per cent in its last quarter, is profitable, and its free cash flow exceeds its net income. Its shares are down 65 per cent. Twitter’s shares are down 40 per cent, while it grew its top line at almost 40 per cent. Spotify, down nearly 50 per cent, grew 27 per cent last quarter. We’m not pitching any of these stocks – we have not done the work – only pointing out that, here and there, there is intriguing dynamism in companies whose stocks have been beat to hell.

It seems entirely possible that Ark will never touch its old highs again. But this could be a good time to pick through the wreckage, all the same.

More than one good read

There were several pieces of excellent journalism about Ukraine in the FT over the weekend. Ben Hall and Roman Olearchyk wrote a useful piece explaining Ukraine’s mixed messages about the threat level. Serhii Plokhy’s essay places the crisis in the context of a long historical process – the break-up of the Soviet Union – and highlights why Ukraine’s allies must keep lending the country “moral, political and military support”.

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