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Weekly Update (11-14 : 11-21): Fed-I Mind Tricks
· Most of us are familiar with the colloquialism, “Jedi Mind Trick,” from the popular Star Wars movie series. The phrase refers to the highly intelligent and gifted “Jedi” who have supernatural powers to use “The Force” to bend their opponents to their will, without any physical touch necessary.
· The telekinetic reference draws a comparison to the US Federal Reserve, and their effect on the stock market. Most are familiar with the concept of “The Fed Put,” which is the idea that if something in the economy goes terribly wrong to such a magnitude that it may negatively impact the stock market, the Fed may step in by easing financial conditions. The “easing” is thought to have a bullish effect on the stock market. To look back at past episodes of the Fed Put, a good reference point is late 2019, when Jerome Powell made an off-the-cuff remark that QT (Quantitative Tightening) was essentially “on autopilot.” The market responded negatively to these comments and sold off 20%. However, 3 interest rate cuts throughout 2019 were thought to have eventually revived the stock market to its former highs.
· A COVID-induced recession in 2020 forced the Fed to cut rates down to zero. The combined monetary and fiscal stimulus totaling over $6 trillion in “free money” and “helicopter money” led to the worst inflation in 40 years. The Fed subsequently raised interest rates over 550 basis points.
· While the interest rate hikes have been painful for the stock market at first, it also introduces this concept of the Fed Put. With inflation easing again, and almost back at the Fed’s target of 2%, prominent investment banks such as Goldman Sachs now expect no recession in 2024, and that the inflation will get back to target by FYE 2024.
· It then begs the question, what is the Fed’s stance on markets? By mandate, the Fed is only supposed to consider inflation, and unemployment. In reality, it looks at a broad swath of financial conditions, up to and including equity market prices and bond market prices. When prices are high, it is thought to have a “loosening of conditions” effect, in a way that could be counter-productive to the Fed’s end goal. Investors have been grappling with this conundrum; Because as asset prices go up, everyday Americans who own stocks feel richer. When folks feel richer, they spend more, and stimulate the economy. This is not what the Fed wants.
· The financial media is obsessed with this supposed doom loop between consumer spending and the Fed. In the end, they say, the consumer cannot win, because loosening conditions will cause the Fed to want to cause a recession.
· We say, “Not so fast,” with interest rates now sitting pretty at 550 bps, I believe the market is failing to appreciate that the Fed put is back. With recent inflation prints coming down strongly and the Fed’s Core Inflation target within spitting distance, the Fed now recognizes in their rhetoric that risks are symmetrical (they must consider the consequences of raising unemployment at least as seriously as the risks of letting inflation run above 2%. I would not call it “Hot” at this point).
· The Fed in this circumstance appears to be Obi Wan Kenobi in one of the recent Star Wars. As his final act, he conjures up a holographic image of himself to lure the enemy away from his friends, allowing them to escape. When the enemy collapses on Obi Wan, they find it is not him at all, and Obi Wan is actually on another planet, projecting his image.
· The “now you see me, now you don’t” posture the Fed is likely to take at this point, flip flopping from the aggressive Fed to the dovish Fed, is likely to take the mainstream media as well as many institutional investors who have been fighting this 7% rally (and YTD 18% + gains in the stock market), by surprise. Since positioning is still “light,” it’d be no surprise to see upside into year end.
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