Fed plays safe as inflation figures roil on
Abraham George Macro Musings
The Fed uses two major tools when it comes to managing its narrative: threats and promises. Until Jackson Hole, Fed Chairman Powell gave the impression that rates are at neutral now and the Fed will be data-dependent in their decision-making going forward.
At Jackson Hole, for some reason, he had some epiphany and moved his goal posts to a level that he won’t be pointed fingers at or criticized like the transitory talk on inflation. With the Fed has kept interest rates close to zero for the last 9 years, people have been conditioned to think that the Fed is a dovish institution. That is not true. But remember the Fed now is more of a consensus institution than at any other time than during the Volcker era or the Greenspan era.
It is just that they overdo things in both directions and when things go wrong they try to be serious firefighters. Take for example Neel Kashkari. You could have never found a bigger dove than him on planet earth. Recently he said that inflation is a “raging inferno”. It’s incredible how they can make an ideological transformation in a split second.
What the Fed really wants to achieve is to follow a path of least embarrassment. They were wrong about inflation initially and they were embarrassed. They just don’t want to make the same mistake again. Instead, it is ok to make another mistake. Two mistakes in a row will make them look too stupid. So they decided to overdo it, which is what is happening now.
So, all the volatility in stocks is on account of this. I think it is very unlikely we will make new lows for the year in stocks and we may not make new highs for the year either. I will give you a good reason why new lows may not happen but never rule out a first time.
The latest bear market rally marked a 50% recovery from the S&P 500 previous highs in January. Whenever this happened in the past 10 bear markets over seven decades it has signaled the ‘real bottom’ for the markets. Let me explain.
In the present condition, stocks regained more than half their overall losses on Aug 12. Take a look at the charts. From June 16 to August 16 the index has moved up 17%. and that really is equivalent to 57% of the overall bear market loss. It never means that we will still continue to get a one-way run up from here and there is every chance this so-called ‘infallible’ indicator can fail eventually. But a 10 for 10 track record for over 70 years is something not to be ignored.
We will develop more on this as the market unfolds but let us analyze the present. As we have stated many times before ever since the Fed has been targeting inflation, their main concern has been the tightening job markets.
For the data-dependent Fed, the August employment report released yesterday should be a bit comforting. The unemployment ticked up and hours worked ticked down. The monthly change in wages was modest. All this points to a rather moderating employment situation.
As mentioned in my last report the next major data release will be on the 13th Sep when we will get the August inflation data and I firmly believe that should be on the decline given the fall in oil prices, particularly for the month of August.
The next major decision on interest rates by the Fed will be on Sep 21st. With a tough-talking Fed and a softening inflation outlook, my hunch is Fed will do less than what the market is pricing in now.
A further catalyst to this rate cycle ending soon is what is happening in Europe now. The western world and the rest of Europe think that they can starve Putin of revenue while Putin thinks he can starve Europe of energy, particularly Germany. I do not think OPEC can fill the shortfall but maybe with Iran’s help.
President Biden’s obsession with cutting more fossil fuel supply into an overly short oil market means that price falls in oil are not sustainable.
We indeed live in interesting times!
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Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and multi-billion dollar portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund.