Hawkish Powell - air pocket in risk assets?

Powell ended up being more hawkish during the FOMC than I expected. Even though the Fed removed their hiking bias, the statement said that they don’t have plans to cut until they have better confidence that inflation is reaching 2%. When asked during the press conference whether it will be possible to have that confidence by the March meeting, Powell replied that March is not his base case. In other words, inflation and labor data must come in exceptionally weak over the next month to justify a March cut.

One of Powell’s major concerns is that the good deflation that has driven much of the disinflation will turn back higher. This is a valid concern, but that risk is offset by ongoing disinflation in rents and weakening labor market data beneath the surface.

In any case, we will not get any tailwinds from monetary policy until May. Coincidentally, the banking crisis that we saw last March flared up again on the same day that Powell decided to come out hawkish. New York Community Bancorp announced earnings losses and a surprise cut to its dividend. The stock closed down 37% after they warned that they would need to set aside more capital for loan losses. Ironically, NYCB was the bank that had purchased Signature Bank’s assets last March, and initially got a boost in stock price for getting such a “great deal”. It turns out those loan assets went from being a great deal to a toxic one.

In other banking news, Japanese bank Aozora shares dropped 20% after revealing losses tied to US commercial property. One has to wonder how many other banks are reeling from CRE losses, just when the Fed decides to stay higher for longer AND end the BTFP. Without the ongoing tailwind of easing financial conditions boosting asset prices, I expect risk assets to hit an air pocket over the coming weeks and months. I am taking a pause from positioning for further disinflation and am now tactically positioning for stagflation. February tends to be a seasonally weak period for the S&P 500, while systematic funds have a lot of selling to do if we see more downside in equities. My expression for this view is to be short risk assets and long USD.

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