Powell hikes 75 basis point and yet Nasdaq & Bitcoin are going to the moon.
What the heck?
While I disagree with the unfolding market narrative here, let me try to explain why we are witnessing such a rally.
A Fed thread.
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What the heck?
While I disagree with the unfolding market narrative here, let me try to explain why we are witnessing such a rally.
A Fed thread.
1/
Despite openly recognizing economic growth is softening, the Fed unanimously (!) decided to hike by 75 bps - it's all about inflation, inflation and inflation.
But markets convincingly started rallying only when Powell went ahead and said the following...
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But markets convincingly started rallying only when Powell went ahead and said the following...
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...''we are now at levels broadly in line with our estimates of neutral interest rates, and after front-loading our hiking cycle until now we will be much more data dependent going forward''.
Let's find out why this was so relevant.
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Let's find out why this was so relevant.
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The neutral rate is the prevailing rate at which the economy runs at its potential - without overheating or excessively cooling down
With this 75 bps hike, the Fed just reached its estimate of neutral rate - from here, they aren't contributing to economic overheating anymore
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With this 75 bps hike, the Fed just reached its estimate of neutral rate - from here, they aren't contributing to economic overheating anymore
4/
But that also means any hikes from here are going to put the Fed in an actively restrictive territory.
The bond market knows that every time the Fed becomes restrictive, they break something.
So Powell was asked a couple of very important questions.
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The bond market knows that every time the Fed becomes restrictive, they break something.
So Powell was asked a couple of very important questions.
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What about bond market pricing?
(70+ bps cuts in 2023)
What about financial conditions?
(Bonds & equities rallying, easier financial conditions)
So: what about forward guidance?
''From here onwards, we are fully data dependent''.
Boom: he ditched it completely.
6/
(70+ bps cuts in 2023)
What about financial conditions?
(Bonds & equities rallying, easier financial conditions)
So: what about forward guidance?
''From here onwards, we are fully data dependent''.
Boom: he ditched it completely.
6/
Why is it relevant?
It all starts from the very strong opinion the bond market has developed about inflation over the last few months: it's gonna move down, and very fast.
Between July '23 and '24, CPI is priced to print at around 2.9% = PCE ~ 2.5%.
Basically at target!
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It all starts from the very strong opinion the bond market has developed about inflation over the last few months: it's gonna move down, and very fast.
Between July '23 and '24, CPI is priced to print at around 2.9% = PCE ~ 2.5%.
Basically at target!
7/
So if Powell is not nearly on autopilot anymore, and markets have a strong opinion on inflation and growth collapsing they can also price all other assets around this base case scenario.
If you look under the hood, market action also validates this narrative.
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If you look under the hood, market action also validates this narrative.
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Who's outperforming here?
Nasdaq & Crypto.
If the Fed isn't gonna force tighter financial conditions on autopilot anymore, real yields will actually start declining again.
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Nasdaq & Crypto.
If the Fed isn't gonna force tighter financial conditions on autopilot anymore, real yields will actually start declining again.
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When real yields decline, valuation-intensive and risk-sentiment driven asset classes outperform.
That's because the marginal return for owning cash USDs becomes less attractive and the incentive to chase risk assets is larger: QQQ & BTC.
Do I think the rally has legs?
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That's because the marginal return for owning cash USDs becomes less attractive and the incentive to chase risk assets is larger: QQQ & BTC.
Do I think the rally has legs?
10/
I can rationalize the narrative being built post FOMC, but no forward guidance = a very, very volatile Fed ahead of us.
One small hawkish turn and it's all gone.
You must price in some additional risk premium here, not less!
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One small hawkish turn and it's all gone.
You must price in some additional risk premium here, not less!
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Finally, what's the bond market saying?
We priced away some hikes between now and December, and this is how we are left:
- 50 in Sep
- 25 in Nov
- 25 in Dec
DONE
- 50 bps of cuts in 2023
A higher likelihood that ''peak Fed hawkishness'' is behind us.
12/
We priced away some hikes between now and December, and this is how we are left:
- 50 in Sep
- 25 in Nov
- 25 in Dec
DONE
- 50 bps of cuts in 2023
A higher likelihood that ''peak Fed hawkishness'' is behind us.
12/
Which also means curves can steepen back a bit as prospects for long-term growth aren't going to be completely slaughtered by a hyper aggressive Fed blindly hiking us into misery.
In terms of portfolio, this FOMC hasn't really changed my assessment.
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In terms of portfolio, this FOMC hasn't really changed my assessment.
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For my longer term portfolio:
- Long 10y+ bonds
- Heavy USD cash allocation
- Minimum exposure to speculative risk assets
For my tactical portfolio:
- Flatter US curves
- Long Nasdaq vs Short Russell
- Short Russell outright
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- Long 10y+ bonds
- Heavy USD cash allocation
- Minimum exposure to speculative risk assets
For my tactical portfolio:
- Flatter US curves
- Long Nasdaq vs Short Russell
- Short Russell outright
14/
Tomorrow, I'll release a deep dive into the Fed meeting on my newsletter TheMacroCompass.substack.com
We will dig deep into the bond market reaction & discuss about what's likely to come next
Consider subscribing so you'll receive the piece directly in your inbox
It's FREE!
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We will dig deep into the bond market reaction & discuss about what's likely to come next
Consider subscribing so you'll receive the piece directly in your inbox
It's FREE!
15/
The Macro Compass is now up to 75,000+ subs.
It's a free platform where I go the extra mile to share even more macro insights & investment ideas.
In the learning journey I'm sharing with this community, I reply to every single comment & question too!
Go have a look :)
16/16
It's a free platform where I go the extra mile to share even more macro insights & investment ideas.
In the learning journey I'm sharing with this community, I reply to every single comment & question too!
Go have a look :)
16/16
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