All Eyes Are on the FED

Uncategorized Jul 01, 2019

Who cares about a Trade War, Cold War or an Iranian War ?

It seems nobody will care as the markets attention is pulled toward Fed Chairman Jerome Powell. I personally, do not fully understand how the market expectations climbed so high in such a short amount of time. Yes, I have repeatedly said that the FED would regret the last two rate increases in 2018, and I even wagered that he would have to walk back the December increase. Just a couple of weeks ago the market was forecasting just one rate decrease, and that it would not happen until early 2020. It seems within days of the market deciding the FED will decrease in December of 2019 that the expectation moved to THREE rate reductions, and all of them coming this year. The first of which is anticipated to happen next month. This puts incredible pressure on Powell and his team because if he shows signs of not moving toward market expectations during this weeks rate decision speech, the market will crumble and likely force the FED to do the very thing he hopes to avoid.

Expectations have swung more wildly than ever!

Check this out! The above chart shows what expectations the market had just LAST MONTH! Can you imagine? The orange lines signify the May expectations, which as you can see show repeated rate increases continuing through 2020. The gray lines signify the current expectations for rate cuts, and they demonstrate an opposite picture of rate reductions that continue through 2020.

The thing about expectations is that, like perception, they can have a tendency to become a reality. The challenge is that the FED likely does not have enough data to push them toward a rate reduction. It's not that the data does not exist, but as I have previously written, we have a FED that seems too continue to put himself on the wrong side of the street. He should not have been raising rates as the signs were pointing toward the end of an economic cycle that never actually boomed. If you study past recoveries you will see that GDP often shot above 6% and wage growth soared. This time, GDP never got exciting and wage growth has been so slow that the middle class is struggling.

Sure, unemployment is at historical lows, but without wage growth, we cannot propel the economy. The FED knows this! The FED also openly discusses the need to fight deflation and to keep close the their 2% inflation target. How can you have inflation without wage growth? Yet given these facts, Powell and his team still raised rates. I didn't get it then, and I don't get it now.

The FED Cannot React to the Yield Curve

The market is freaking out because the spread between the 3 month rate and the 2 year rate has gone negative. While it is true this event has preceded the last seven recessions, it does not provide the FED the empirical data that they need to reduce rates. Technically, even a multi thousand point drop in the stock market is a good reason to lower rates. Unfortunately, prior Feds have given away money to pull us out of the deep 2008 recession. When cheap rates did not do the trick, they started with quantitative easing. This environment has helped create one of the biggest asset bubbles I have ever experienced. I am referring to the Stock Market. Bubbles must pop, but even though the FED created the asset the bubble, their goal was not to drive the equity markets. Their goal was to stimulate the economy. If the Fed did not do this, it's not likely that the equity markets would have ballooned. My point here is that it is within the FED charter to keep the economy growing, but not to prop up the markets, and I think if he does not act, the markets will topple.

The below chart shows what happens each time short term rates exceed those of long term rates. It is clear to see that the S&P plummets each time the yield curve inverts. Is it too late for the FED to stop this?

So, what has changed since the last FED meeting? We got a weak Non-Farm Payroll number and inflation came in near the Fed target. The conflict with China is more or less where it was last month and the Stock market bubble continues to build. With limited vision it's not tough to see why the FED will have a hard time lowering rates.

The Feds Focus is on Maintaining a 2% Inflation Target

One Word Will Tell the Entire Story

Very few people, including myself, expect the Fed to lower rates this week. However, there is a huge expectation built into the market that the Fed will remove the word "patient" from his speech this week. Previously, Powell has stated that they have their eye on things, inflation is transitory, and that it can afford to be patient. This word need to go bye-bye or the stock market will likely go boom-boom. It will be an interesting week. I plan on staying neutral in our options positions going into the week. We will likely go long on gold and possibly long on treasuries. We will be ready to buy the VIX and the UVXY if the FED speech does not remove the word patient.


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