Will Stocks Flop as the Fed Drags Its Feet on Rate Cuts?

Key Concepts

• FOMC Minutes: Records of the Federal Open Market Committee meetings, providing insights into the Fed’s thinking on monetary policy.
• Disinflation: A decrease in the rate of inflation.
• Break-Even Inflation Rate: A market-based measure of expected inflation.
• Non-Farm Payrolls: The number of jobs added to the economy each month, excluding farm workers.
• Core Inflation: Inflation excluding volatile food and energy prices.
• Expansionary Fiscal Policy: Government spending and tax cuts designed to stimulate economic growth.
• Tightening (Monetary Policy): Actions taken by a central bank to reduce the money supply and increase interest rates.
• Shadow Fleet Tankers: Vessels used to circumvent sanctions by transporting oil.

Market Overview & Recent Performance (February 20th, 2024)

The week commencing February 19th saw muted movement in stock markets, reacting to headlines from the Middle East but without significant directional change. The S&P 500 declined 1.5%, while the NASDAQ fared slightly better, down 1.4% (compared to a 2.1% drop the previous week). Bond yields decreased – the 10-year Treasury yield fell 3.8% and the 2-year yield 2.4%. Crude oil saw a minor decrease of 1%, remaining within its recent consolidation range due to ongoing US-Iran tensions. Gold experienced a 1.3% increase (following a 1.7% gain the prior week), while the dollar remained relatively stable.

The Japanese Yen strengthened by 2.8% following the election of Prime Minister Takahayi Sana, with expectations of expansionary fiscal policy and continued, albeit gradual, tightening by the Bank of Japan (BOJ). Bitcoin saw a 2% decline.

Earnings Season & Economic Data

Despite market sluggishness, S&P 500 firms reported earnings tracking at 13.2% year-over-year for Q4, up from 8.3% previously. Tech companies are outperforming, with earnings growth at 30.7% year-over-year (up from 25.8%). Both earnings and revenue figures for technology companies have exceeded expectations by 8.3% and 3% respectively, despite skepticism surrounding the AI narrative.

US jobs data presented a mixed picture. Headline non-farm payrolls came in at 130k (significantly above the expected 70k), and the unemployment rate fell to 4%. However, substantial downward revisions to prior data revealed that the economy added half a million fewer jobs in 2024 and 2025 than initially estimated. Specifically, 2024’s job additions were revised down to 1.5 million from 2 million, and 2025’s to 181,000 from 584,000.

CPI Report Analysis (February 14th, 2024)

The CPI report released on February 14th showed core inflation falling to 2.5%, the lowest since May 2021. The headline inflation rate also decreased to 2.4% (below the expected 2.5%). Disinflation was broad-based across services, goods, food, and energy. However, the significant drop in energy prices (0.15 percentage points) was the primary driver of the headline decline.

While encouraging for those hoping for Fed easing, the speaker notes the potential for oil prices to rise again, given ongoing geopolitical tensions and China’s evolving energy supply needs (increasing reliance on sanctioned sources like Iran, Russia, and Venezuela). Rising oil prices are already reflected in increasing break-even inflation rates, which typically translate into CPI increases a month later.

Fed Policy & Market Expectations

The speaker highlights a disconnect between the economic data and market expectations. The mixed jobs data and CPI report leave room for interpretation – either signaling a strong economy that allows the Fed to delay rate cuts, or indicating underlying weakness that necessitates easing.

Markets are currently pricing in 58 basis points of rate cuts for 2024, with expectations shifting towards cuts starting in June and potentially extending into mid-2025. This is more dovish than the Fed’s current guidance of one cut this year and one next. The upcoming FOMC minutes are crucial for understanding the Fed’s internal debate – specifically, how much weight they will give to near-term energy price increases versus the broader trend of disinflation.

Chair Powell’s statements after the FOMC meeting indicated a moderate economic pace, some stabilization, and diminished risks to both sides of the Fed’s mandate, suggesting a cautious approach to rate cuts.

Trading Strategy & Positioning

The speaker’s current positioning reflects a slightly bearish outlook:

• Short US Dollar: Based on the expectation that the FOMC minutes will lean towards continued rate cuts, but not drastically alter the Fed’s overall perspective.
• Long Australian Dollar, Pound, and Euro: Benefiting from a weaker US dollar.
• Short Bitcoin: Maintaining a negative outlook on Bitcoin.
• Long Brazilian Stocks (via ETF): Benefiting from strong performance year-to-date.
• Short US Equities (via Put Verticals): Expecting continued market weakness driven by a lack of urgency from the Fed, rather than negative fundamental news. These puts will likely be rolled in the coming days due to their short time to expiration.
• Long Crude Oil: Anticipating continued disruption to oil supply due to geopolitical factors and China’s energy needs.

Notable Quotes

• “The market is kind of sitting here on tender hooks waiting for things to happen. Not rallying but not really breaking down either.” – Describing the current market sentiment.
• “If it's not the earnings flow then what is it?” – Questioning the drivers of the recent market weakness despite strong earnings reports.
• “The numbers end up looking mixed and the markets end up saying well hold on here. What is it that we're actually looking at?” – Highlighting the ambiguity of recent economic data.

Logical Connections

The analysis progresses logically from a review of recent market performance to a detailed examination of economic data (jobs and CPI), then to an assessment of Fed policy and market expectations. The speaker then connects these factors to his current trading strategy, explaining how his positions are designed to profit from the anticipated market response to the FOMC minutes. The discussion of energy markets and China’s role is interwoven throughout, highlighting its potential impact on inflation and overall economic conditions.

Conclusion

The current market environment is characterized by uncertainty and mixed signals. While economic data shows some positive trends (disinflation, strong earnings), revisions to prior data and geopolitical risks create ambiguity. The Fed faces a delicate balancing act between supporting economic growth and controlling inflation. The speaker anticipates that the FOMC minutes will provide further clarity, but believes the market is likely to remain cautious, potentially leading to continued weakness in US equities and a strengthening of other currencies. The key takeaway is that the market’s dovish expectations may be overextended, and the Fed is unlikely to deliver the aggressive rate cuts currently priced in.