Meme Traders 1, Federal Reserve 0
The Federal Reserve increased interest rates by 0.25% annually to 4.50%-4.75% as expected at its meeting this week. The Fed’s press release appeared carefully worded defy market expectations of an inevitable turnaround was clamoring for markets. Markets were heading into the press conference humbly, but one question changed everything.
Asked if Powell was concerned about the rapid easing of financial conditions since October, the Fed chairman said he was not. So what does Powell get at when he says he doesn’t care about easing financial conditions? Real-time financial terms are dramatically lightened before anyone even passes the mic for the next question! Carvana ( CVNA ), Tesla ( TSLA ), Nvidia ( NVDA ), AMC ( AMC ) led the furious rally.) and altcoins. This played into the hands of market speculators who bought short-term call options heading into the Fed meeting, hoping that a squeeze would develop.
You can mark this turning point at the bottom of the chart after 2:30 PM Eastern. At the closing bell, the S&P 500 ( SPY ) pushed above 4,100 from the 4,000 level, while the NASDAQ ( QQQ ) doubled in strength. The Dow (DIA) was near flat for the day.
Powell had a prime opportunity to walk back massive bets that the Fed would soon resume quantitative easing to bail out stock market speculators. He didn’t call the market’s bluff, instead choosing to fold his cards and let the rally accelerate. Worryingly, the market rose further when Powell gave a cryptic response to a question about whether the Fed would monetize US federal debt if Congress refuses to raise the debt ceiling. This led to a strong sell-off in the US dollar and lower Treasury yields. The dollar’s decline is not unusual from dovish Fed meetings, but it was fueled by traders losing faith in the US dollar after dumping tons of money since the outbreak of war in Europe last year.
The Fed Should Focus on Easing Financial Conditions
Powell didn’t call the market’s bluff, and that might sound like a big deal, but the reaction from the stock market was immediate and strong. Higher stock prices (especially in meme stocks) create a wealth effect among consumers and lead to higher spending. Lower bond yields encourage more borrowing. A weaker dollar tends to raise import prices like clockwork. The risk here is that the Fed is consistently wrong in forecasting inflation, so if they still err on the downside, their credibility is completely compromised, just as it was in the 1970s.
There are some well-known factors that will lower inflation, mainly lower house and used car prices and expectations of peak rents. But there are some factors that push it back. The declining value of the dollar is a big factor pushing prices back up, but there are other factors as well, including annual wage increases and annual COLA adjustments from government programs like Social Security. While core services inflation is yet to show any sign of slowing down, the fall in second-hand car prices appears to have stalled.
Don’t look now, but core inflation accelerated month-on-month in Spain and Italy. Core inflation for Tokyo also surprised traders for January. These were no small surprises for the upside either, with Spain’s core coming in 0.9% above estimates and Italy by a similar amount. What should we make of them? I don’t know for sure, but I can’t help but think these are good news. Unfortunately, policymakers have a long history of trying and failing with half-measures on inflation, only to then be forced to double down when inflation doesn’t go away.
All of these are reasons why the Fed is definitely calling the market’s bluff and Fed pivot traders are backing off their bets. Personally, I would pay less attention to rate hikes, which have been repeatedly rejected by traders, and more attention to the Fed’s balance sheet, particularly its portfolio of mortgage-backed securities. This would send a clear message to traders who intend for the Fed to pivot.
Market Won by Bluffing Bad Cards
The S&P 500 is priced near 2021 highs, especially with the technology sector the biggest gainer today after the Fed meeting. Not every stock is overvalued in every market, but cash is paying 0.25% more annually this month than it did last month, while the compensation you get from stocks is down because you’re paying about 108 cents for every share dollar. could have bought it four weeks ago.
Why Powell didn’t call the market’s bluff and what the Fed was thinking internally is anyone’s guess. The Fed may pop the speculative bubble in stocks by 2021 as another mania not unlike the tech bubble of the late 1990s when monetary policy was tight. But the Fed has the pandemic housing bubble lock, stock and barrel. They literally and figuratively own something like 30% of all outstanding mortgages. And they allowed workers to be completely crushed by pandemic money printing while using QE to boost their 0.01% assets. It would make a lot of sense for Powell to say that the Fed is worried about market speculation and could raise interest rates further to stop it, but he hasn’t, at least for now.
You don’t have to participate in the casino if you don’t want to. Stocks can hit all-time highs in pivot mania and then crash, and you’ll still get about 5% in cash over the next year.
The future challenge is the Fed putting the market on a pedestal. If US inflation follows some early indicators overseas and surprises to the upside as the market rates the fastest disinflation in history, stocks will pay a steep price later, despite successfully bluffing the Fed now. The word crash may be a bit of an exaggeration, but past CPI shocks in the market have resulted in one-day index declines of around 5% and monthly declines of close to 10%. It may not capture the market this month or even next, but the combination of hundreds of zombie companies backed by high valuations, rock-bottom consumer savings rates, misinvestments in the economy and low interest rates is guaranteed to cause trouble at some point. .
Michael Burry shared just one word of advice for investors. “Sell.”