Market momentum is Red. Cash remains your best option as investors prepare for the FOMC announcement on Wednesday. That said, Tuesday again proved to be the best day for the markets… as the losses weren’t as bad as we’ve seen during other days of the week. Remember that cash is a position, especially as we await the Fed’s move.
Last night, I had dinner with a few colleagues who were floored by the market’s reactions over the last few days. Even the most conservative trading strategies – selling deep out of the money credit spreads – are getting smoked. It’s hideous out there.
Momentum went negative last Thursday afternoon, and the violent moves downward are part of the experience of a Red momentum switch. The rush accompanied a massive shift in sentiment over the Fed’s rate hike plans for tomorrow.
As I’ve said before, the odds of rates hitting 2.25% by July were at 0.1% on June 2. Today, the odds are at 92.4%, and some traders speculate on a 2.5% rate by the next Fed meeting. For tomorrow, the odds of a 75-point hike sit above 92%.
Since Friday’s CPI reading, the markets had a wake-up call. The Federal Reserve is too far behind the curve on inflation, and they’ll need to take a whip at the equity markets by raising interest rates and draining liquidity from the economy.
The Fed will likely sell $15 billion in bonds and mortgage-backed securities tomorrow, helping to reduce the flow of money in the market. That tightening always spills over into the stock market.
But there’s a question that I have to ask… Are 75 points all they’re going to do? Is a full 100-point hike possible?
Powell’s Statement on Rate Hikes
Every Wall Street bank raised its rate hike expectations to 75 basis points since Friday. One analyst from Standard Chartered, a bank based in the United Kingdom, suggested an outside chance of a 100-point hike tomorrow.
That would be staggering. One of the things that Jerome Powell is known for is his predictability. This Federal Reserve does not like to surprise the markets or the economy. But I point back to Powell’s statement just a few weeks ago. The Fed needs to do whatever it takes to get inflation in order.
“I think the one thing we cannot do is to fail to restore price stability…” he said in June. “Nothing in the economy works; the economy doesn’t work for anybody without price stability.”
I’m seeing many Wall Street banks now project the Fed funds rate hike of 3.25% by the end of 2023. I think there is an outside chance that we see 5%. The reason: The reality of the Consumer Price Index.
Yes, it is expensive to short stocks, especially with puts. But I have a hunch that the situation with inflation is far worse than the PhDs are leading on.
Remember, cash is your best defense, and so are energy stocks – particularly oil companies across the entire supply chain. So use pullbacks like we saw Monday as an opportunity to buy on the dip or sell credit spreads. Oil will be at $150 before we know it.