Will the Fed Disappoint the Stock Market Again?

Macro Money - Market Analysis & Fed Policy Outlook (January 29, 2024)

Key Concepts:

• Event Risk: Significant upcoming events (primarily the Fed meeting) that have the potential to drastically impact markets.
• Hodler: A long-term investor, particularly in cryptocurrencies, who holds onto their assets despite price volatility.
• Break-Even Rate: The difference between the nominal yield on a Treasury security and the expected inflation rate. Used to gauge inflation expectations.
• Illiquid Market: A market where it is difficult to buy or sell assets quickly without significantly impacting the price.
• Prepositioning: Adjusting portfolio holdings in anticipation of a future event or market movement.
• Dovish/Hawkish: Terms describing central bank policy. Dovish implies a willingness to lower interest rates to stimulate the economy, while hawkish suggests a preference for raising rates to control inflation.
• GDP (Gross Domestic Product): The total monetary or market value of all final goods and services produced within a country’s borders in a specific time period.
• PMI (Purchasing Managers' Index): An indicator of the economic health of the manufacturing and service sectors.
• CPI (Consumer Price Index): A measure of the average change over time in the prices paid by urban consumers for a basket of consumer goods and services.
• Shadow Fleet: A network of tankers used to circumvent sanctions and transport oil, often from countries like Russia, Iran, and Venezuela.

I. Market Performance & Initial Conditions

The week prior saw significant divergence in asset performance. While the S&P 500 was down slightly and NASDAQ flat, precious metals experienced substantial gains, particularly gold (+8.3%). The dollar weakened, while the Euro and Yen strengthened. Bitcoin, contrary to the “digital gold” narrative, declined (-6.6%) during this period. The speaker emphasizes this wasn’t a risk-off move, as stocks barely moved. A key driver potentially tying these movements together is the rise in crude oil prices.

At the start of the current week, the S&P 500 recovered from a downside gap triggered by concerns about a potential government shutdown due to expiring funding deals and events in Minnesota. However, the index remains below October highs, a level it hasn’t surpassed since Fed Chair Powell’s hawkish comments regarding rate cut expectations. The dollar experienced a significant gap down but lacked follow-through. Silver exhibited extreme volatility, reaching a high of 117+ before a substantial reversal, raising questions about speculative froth versus strategic repositioning.

II. Event Risk: The Federal Reserve Meeting

The primary event risk for the week is the Federal Reserve’s monetary policy announcement. While a rate cut is highly improbable (less than 3% chance), the focus will be on the accompanying commentary and Fed Chair Powell’s press conference. Powell is expected to face questions regarding recent subpoenas and a “proof of life” video released in response, addressing accusations of White House pressure to cut rates. He reiterated the Fed’s commitment to data-dependent policy.

The Bank of Canada rate decision, Eurozone GDP data, US PPI data (released over the weekend), and Chinese PMI data are secondary events, all overshadowed by the Fed’s announcement. The speaker argues the Fed’s communication is paramount, influencing all markets. The market is perceiving a high degree of one-sidedness ahead of the Fed meeting, contributing to the silver flush.

III. Rate Cut Expectations & Market Sentiment

Current market expectations anticipate one rate cut in June, with a slightly less certain second cut in December. However, the overall outlook is becoming less dovish, with only 39 basis points of cuts priced in for the rest of the year and 44 for 2026. This shift in expectations correlates with a stalling in the S&P 500’s momentum. The speaker notes the S&P 500’s rally from April 2023 lows coincided with increasing dovish rate expectations, and that momentum has now stalled.

The market’s desire for two cuts this year, compared to the Fed’s projection of one now and one next year, indicates a sense of urgency and dissatisfaction with the Fed’s cautious approach. The speaker quotes the market as wanting rate cuts because they haven’t been delivered.

IV. Economic Data & the Fed’s Position

Economic data currently supports the Fed’s stance. Third-quarter GDP numbers were strong, driven by a rebound in consumption after disruptions caused by earlier tariff-related inventory adjustments. Recent PMI data, released Friday, showed continued growth in both the manufacturing and service sectors, despite a temporary slowdown during the 43-day government shutdown. The ISM service sector data further reinforces this positive outlook.

The Atlanta Fed GDPNow model currently projects a stronger fourth-quarter GDP than consensus estimates, further bolstering the Fed’s argument against immediate rate cuts.

V. Inflation & Crude Oil Dynamics

While goods inflation appears to be stabilizing, services inflation remains a concern. However, the recent surge in crude oil prices introduces a new complication. The speaker attributes this rise to a confluence of factors, including geopolitical tensions (Venezuela, Iran, Russia) and disruptions to China’s access to discounted crude oil via a “shadow fleet.” This disruption forces China to purchase oil at market rates, impacting global supply and prices.

The lag between crude oil price changes and their impact on CPI (approximately 1-1.5 months) is highlighted. Rising crude oil prices are already reflected in increasing inflation expectations, as evidenced by rising 5- and 10-year break-even rates. This inflation risk further complicates the case for rate cuts.

VI. Market Uncertainty & Positioning

The speaker emphasizes a high level of market uncertainty, reflected in the economic policy uncertainty index, which is experiencing greater intraday swings than even during the peak of the COVID crisis. This uncertainty stems from various geopolitical events and policy shifts, including tariff threats and the Greenland issue. Despite the president walking back some of these policies, the overall impact on global trade has been negative, with the first decline in global trade since the COVID lockdowns and the largest since the 2008 financial crisis.

This decline in global trade poses a risk to the AI boom, which relies on smooth international supply chains and has been a key driver of market performance. The speaker argues the market is seeking rate cuts as “insurance” against these risks.

VII. Trading Strategy & Outlook

The speaker’s current positioning reflects a short-risk bias:

• Short SPY & QQQ (via put verticals): Betting against broad market gains.
• Short Bitcoin (via put verticals in IBIT): Expecting further declines in Bitcoin.
• Long Gold: Maintaining a bullish outlook on gold.
• Short Silver (via call selling): Anticipating a pullback in silver after the recent surge.
• Short US Dollar: Expecting further dollar weakness.
• Short Bonds (TLT & belly of the curve): Expecting rising interest rates due to uncertainty and potential inflation.

The speaker concludes that a dovish Fed announcement would likely disappoint the market, given the current economic data and inflation risks. He anticipates continued volatility and recommends a cautious approach.

Notable Quote:

“It’s not that the markets want rate cuts because they’ve established what the threat is. It’s that they want rate cuts because they haven’t.” – Speedback, Tasty Live.