Foreword
This is a quick note, which tends to be just off the cuff thoughts/ideas that look at current market situations, and to try to encourage some discussions.
The Federal Open Market Committee (FOMC) is meeting next week, with a decision due on Wednesday. With all that’s going on, the Fed’s actions is quickly becoming one of the only things that matter in the markets.
As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.
If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.
What next?
Everyone is, of course, concerned about where the Fed is heading with regards to interest rates. While inflation is still extremely high, there are mixed signs that it may be coming down, so in the past week or so, despite horrendous earnings by some of the country’s largest companies, stocks have been generally going upwards.
Bull case
The bull case for stocks right now seems to be some mix of the following:
- At the margins, some of the leading causes of inflation (used car prices, housing prices, etc.) have started to come down, and in some cases, dramatically so, hinting that the Fed’s policies may be working, and they may be tempted to ease up.
- Quite a few companies have been warning about their profits, as well as near term profit forecasts, suggesting an economic recession may be in our near future. To head that off, the Fed may want to ease up on the hikes or even outright ease policies.
- The Fed has said many times that the goal is to hike to a suitable rate, and then hold rates there for a while. Maybe they are at that rate already and can stop hiking?
- The dollar is extremely strong right now, causing much consternation to the rest of the world and notably many of America’s allies. Going slower on hikes will alleviate that somewhat and make lives easier for America’s friends.
- The strong dollar is also causing export oriented American companies to face strong headwinds in their businesses, leading to several rounds of layoffs already in some large companies.
Bear case
And the bear case for stocks right now seems to be some mixed of the following:
- While the initial causes of high inflation have somewhat abated, inflation seems to have spread to other parts of the economy. More worryingly, “sticky inflation” (1) seems to be going up, suggesting more effort to combat inflation may be needed.
- The Fed, through Powell, has said many times that they wish to avoid the mistakes of the 70’s where rates were lowered only to see inflation return with gusto, leading to even more future hikes.
- Powell has also been, of late, using words and verbal imagery, sometimes even outright invoking Volcker’s name. As we know, Volcker is famous for breaking inflation in the 70’s by raising rates relentlessly, arguably to the point where he went slightly overboard.
- Compared to inflation, Fed funds rate is still extremely low, and despite everything, inflation is still extremely high.
- Inflation is, first and foremost, a sentiment issue. Preventing the seed of higher expected future inflation from taking root is critical to containing inflation. The Fed has said many times that they are concerned with that seed being planted in people’s minds, and the recent calls for higher wages suggest the self-reinforcing cycle of higher inflation may be getting started.
Which is it?
There’s a lot riding on the Fed’s decision on Wednesday, and possibly even more on Powell’s press conference right after. How much the Fed rises rates by, what their dot plot hints they are thinking for the future, and what Powell says and even the tone he uses to say it — all these will be put under the microscope and analyzed to a degree that probably borders on crazy.
Getting the Fed’s nuances, and more importantly the market’s reactions to those nuances, right and doing so consistently this year will have almost guaranteed stellar portfolio performance. Since I’ve yet to retire, you can assume that I haven’t done so. 😉
Footnotes
- Sticky inflation is inflation of goods that tend to have more sticky prices, as in their prices don’t tend to move as much, but when they do move, they tend to stay at the new price level for longer.
Janky Thoughts 