On Wednesday morning, we had a negative momentum switch as investors continued to dump those “economy stocks” that I discussed on Friday. Consumer cyclical, technology (semis), industrial, and financial stocks remain under pressure. Institutions were not buying again on Wednesday, evidenced by the lower volumes that define this market. Today featured a “headline” event in the release of the Fed’s minutes from its recent meeting.
While we already knew that the Fed was moving to increase rates aggressively to tame inflation, there are a few BIG takeaways from these minutes that we need to discuss. Let’s dive in.
Fed’s March Minutes
As you know, I don’t care much about the rate hikes. I knew they were coming. So, I don’t give a hoot if the Fed raises rates by 25 or 50 basis points in May. And I’ve noted that the odds of higher rate hikes are pushing traders in various directions.
There is now a slight chance (under 2%) that the central bank will set its benchmark rate up to about 3.5% by February 2023, according to CME FedWatch. But the large institutions that I advise effectively argue that we won’t get close to this… Why? Because “Smart Money” is expecting that rate hikes and tightening consumer spending would create weaker economic conditions toward the end of the year and Q1 2023.
The institutions expect that the Fed will start to aggressively increase rates over the coming months and create enough runway that the central bankers can cut rates to support the economy. That’s a VERY BIG gamble, but it wouldn’t be unprecedented.
This chart from Bloomberg shows that the markets expect significant rate hikes over the next 12 months. However, the market is starting to price in rate CUTS in 2023/24 when the economic fallout happens. Simply put, we’re facing a very unpredictable market.
Momentum Tells Us What
I am watching momentum right now turn negative. This enhanced selling pressure could last three days or three weeks. But we are always at the risk of Bull Traps – events where there are lower highs and higher lows as the market starts to drop. There is never a straight line down like what we saw on Black Monday in 1987. Instead, the market chops as algorithms spasm to squeeze dollars and draw new buyers into the market.
In red momentum markets, I’m typically sitting on cash, but there are opportunities in the short-term in positive sectors like natural gas and shipping.
That said, I’m looking out to June as the next time we see robust volatility. Not only is that the time where we could see the Fed hike rates by 75 basis points in a single meeting, but that is also the likely time that the Fed starts to reduce its $9 TRILLION balance sheet.
Today, the Fed’s minutes explained it would begin to cut $95 billion per month from its balance sheet per month – and start soon. There isn’t a lot of data on this process. However, back in 2018, when the Fed cut $50 billion in nine months during 2018, we had a pretty large peak to trough decline.
We’re talking about an even faster decline in liquidity from the market than what we saw. Here we’re talking about $60 billion over three months. That would also tack on another $35 billion in mortgage-backed securities, a pace much faster than we saw in 2018.
Fed’s Minutes Takeaways
Simply put, it’s time to put on your seatbelt. The Fed has been backed into a corner, and it must start raising rates and tapering that balance sheet. It could create some VERY WILD moves in the markets and in your more illiquid assets in housing, metals, or private investments.
A recession is very likely if the Fed can’t provide necessary support anymore. I do believe that the play will be to raise rates and lower them later. The good news is that when we enter a bear market… you’ll be prepared to make a lot of money over the long term. We’ve got a long nine months ahead of us, and I’ll be here to help navigate you through this. Remember… cash is your friend right now.