The one-off hike that was never going to be one-off

RE: The one-off hike that was never going to be one-off

Fellas,

Let's begin with what the equity market did on Thursday. It took a Fed rate hike, the first in more than three years, and treated it like a fire drill. The Nasdaq jumped 1.7% to 26,418.3, the S&P 500 rose 1.1% to 7,637.76, and the VIX dropped 12.8% to 15. Twenty-four hours after Kevin Warsh raised rates, the fear gauge was back at the level of a man who has just been told the biopsy was benign.

The biopsy was not benign. Warsh hiked a quarter point and signaled more to come, which killed the comfortable assumption of a single adjustment. Read that again. Nobody was surprised that he hiked. People were surprised, or pretended to be, that he meant it. For four months the trade rested on a story: the new chair arrived with a roadmap to lower borrowing costs, so whatever he did now was a detour. Less than four months after he took the job, the first move was up. Roadmaps get you where the driver wants to go. The driver has just told you where he wants to go.

Now to the bond market, which does not do denial.

By Friday, the 10-year yield had climbed back above 5%, at 5.004%. The 2-year sat at 4.743% and the 30-year at 5.336%. The 10- and 30-year yields are at levels last seen in 2007. Take a moment with that year. In 2007 the S&P was making its last high before it fell 57%. I am not predicting a repeat. I am observing that when the long end is priced like it's 2007 and the equity index is priced like it's 2021, one of the two is going to lose an argument.

The equity bulls do have a case, and here it is. Oil is retreating. Crude fell for a third straight day on Friday, even with Saudi Arabia and the Houthis trading strikes across their border. Payrolls-type data is solid. Chipmakers keep rallying. Fine. But look at what the oil relief bought us. It bought a rebound to a 5% ten-year, in a week where the same 5% arrived on bets that oil near $100 could feed inflation and force more Fed hikes. The market is now stuck in a loop. Cheaper oil lets stocks breathe, and the breath fogs the window on the inflation problem that the Fed just told us is real. Every dip in crude is a stay of execution, not a pardon.

The rest of the G7 is not helping. The Bank of England held at 3.75% on Thursday, exactly as expected, though markets are pricing something close to four hikes there, and Andrew Bailey himself said the outlook was too unpredictable to say whether that pricing is right. That is a central banker declining to talk anyone down from four hikes. Meanwhile economists expect the ECB to wait until December for what they call a final increase, and I would file the word "final" alongside "one-off" in the drawer of things central banks say to be polite.

Then Tokyo. The Bank of Japan raised rates on Friday to a 31-year high and hinted at more. Consider the sentence structure there. Thirty-one years. An entire generation of carry-trade infrastructure was built on the premise that Japanese rates were a natural feature of the landscape, like the tide. Then the yen pared its drop on a report of a rate check, the step that usually precedes intervention. So the Ministry of Finance is leaning on the currency at the same moment the dollar is having its best week since June, up 1.1% on the Dollar Index. A strong dollar, a stressed yen, and a 5% Treasury is not a cocktail I would serve at a party I cared about.

Which brings me to the day's real curiosity: the option expiry. Friday's triple witching was the second-largest on record, and Citadel Securities put the expiring notional at about $7 trillion. Seven trillion. Dealers spent the session rolling, hedging, and rebalancing, and the S&P edged up even though most of its members fell, because the chipmakers carried it. I want to be careful about how much weight a flow-driven Friday deserves. It deserves very little. But an index that rises while the median stock falls, during the largest mechanical rebalancing of the quarter, is telling you that the tape is being held up by a handful of hands. Ask yourself what those hands are holding.

I'll tell you what they are holding: an AI trade whose own leadership is getting cold feet. Top industry executives urged a slowdown in the development of the technology this week, and nobody has any clarity on what a slowdown would look like. Think about the pitch for a moment. The multiple on semiconductors assumes exponential demand. The people building the demand are asking to slow it down. And the discount rate used to value those cash flows just went to 5%. Somewhere a spreadsheet is quietly recalculating.

Bitcoin, for the record, topped $81,000 this week, which tells you liquidity is not exactly being drained from the speculative end. Crypto is treating a 5% risk-free rate as a rounding error, which is either brave or the last chapter of a very familiar book. I am agnostic, and I say that with the calm of a person who has been wrong on both sides of this.

Recommendations, such as they are:

The 10-year at 5% is a line the market has now touched twice in one week and bounced off twice. Pay attention to the third touch. A break on the other side, with the Fed openly in tightening mode, means the equity risk premium has to be repriced, and a VIX at 15 offers no cushion for that.

Do not confuse a good Thursday with a regime change back. One session of relief after a hike is a dead-cat bounce with better PR.

Watch the yen. If Tokyo is checking rates and Washington is hiking, the pressure has to go somewhere. It usually goes through the carry trade, and it usually arrives on a day nobody scheduled.

Finally, remember what the setup asks of you. It asks you to believe that a Fed chair who just hiked and promised more will stop the moment stocks wobble, that oil will behave, that the AI capex story survives a 5% discount rate, and that Japan's first serious tightening in three decades is a rounding error. That is four independent miracles. I have seen markets survive two.

Regards,
The Desk

P.S. If you are reading this Saturday and hoping the weekend fixes it: the bond market trades Sunday night in Asia, and it does not read memos.