Weekly Chart Review
Rate cuts or no rate cuts? Which is it?
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Weekly Chart Review
The big news of last week was the FOMC meeting which concluded on Wednesday. However, the “big news” wasn’t that the Fed left rates unchanged, as that was largely expected, it was what FOMC Chairman, Jerome Powell, said at the press conference following the rate decision announcement.
But first, let’s take a trip back to December 1st when J. Powell made the following statement during his opening remarks at a Fireside Chat at Spelman College, in Atlanta, Georgia:
“It would be premature to conclude with confidence that we have achieved a sufficiently restrictive stance, or to speculate on when policy might ease. We are prepared to tighten policy further if it becomes appropriate to do so.”
Fast forward to December 13th during the press conference following the rate decision announcement where J. Powell made this statement:
“The question of when will it become appropriate to begin dialing back the amount of policy restraint in place — that begins to come into view, and is clearly a topic of discussion out in the world and also a discussion for us at our meeting today…”
In less than two weeks, the Fed went from (paraphrasing) “Policy may not be restrictive enough and we may need to consider hiking rates further…” to “We may need to soften our policy stance, and to that end, we talked about cutting rates at our FOMC meeting today…”
That seems like a complete 180…what changed?
To make matters even more confusing, on Friday, after the customary “blackout period” ended, the first Fed official to make a public statement was New York Fed President John Williams and he said:
“We aren’t really talking about rate cuts right now…”
Mr. Williams was in the room during the FOMC meetings two days prior, so which is it, is the FOMC talking about cutting rates or are they not?
It seems like such a simple statement, yet the market really keyed in on it.
Here is a 15-minute chart of S&P 500 futures directly following the rate decision announcement and J. Powell’s press conference…
Here is the same time frame, but instead, we’re looking at the yield on the 10-year US Treasury…
Fast forward to Friday when Fed President Williams suggested that the FOMC really isn’t talking about cutting rates right now and here’s how S&P 500 futures reacted…
At the same time, the 10-year US Treasury had the following reaction to those comments…
Very simply…the market is suggesting:
Rate cuts = higher equities, lower UST yields
No rate cuts = lower equities, higher UST yields
Do you really want the Fed to cut rates?
The knee-jerk reaction from most people (and the stock market) is probably, “Yes, that would be a welcomed outcome”.
Let’s look at what has happened over the last 20+ years of Fed policy.
In the chart below, I am showing the S&P 500, the Fed Funds rate (blue line), and recessionary periods in the US (red vertical bars).
Each of the last three times we saw rate hikes by the Fed, they were followed by a pause, and then an aggressive easing campaign.
Each time, this aggressive easing campaign was either associated with and/or led to lower values on the S&P 500 and a recession.
The very simple observation is that over the last 20+ years, rate cuts tend to be associated with lower equities and a recession.
Despite this, the market is giddy at the possibility of the Fed cutting rates.
Put yourself in the Fed’s shoes
With rates at 5.25% - 5.50%, if the economy isn’t imploding, why would you cut rates just to cut rates? You’d rather err on the side of keeping as much ammunition as possible (i.e., rate cuts) for when you need it.
Further, if you cut rates too soon (i.e., cutting rates just to cut rates), you risk reigniting the economy and increasing the chances of inflation coming back. This is exactly what happened in the 1970’s and it took Paul Volcker raising rates to 20% to get inflation under control. No one wants to see a repeat of this.
All else being equal, if I’m the Fed, I’m inclined to drag my feet on cutting rates because even if I move too late, and incite a recession, that’s a better outcome than what would happen to the economy if inflation comes back and we’re talking about double-digit rates to try and get inflation under control.
Is a “Soft Landing” realistic?
I think the market is giddy over the prospects of rate cuts because the market believes that the economy is going to have a “soft landing”.
While not impossible, to have a “soft landing”, the Fed has to execute its monetary policy perfectly.
If you rewind the tape to just two years ago, there probably wasn’t a person on the planet who didn’t believe we were beginning to see inflationary pressures rear their ugly head. Despite that, the Fed insisted it was “transitory” and didn’t act until it was too late.
If you are hanging on to the “soft landing” narrative, you are counting on these same Fed officials, who blatantly missed the obvious last time, to perfectly thread the needle when history (both recent and longer-term) is stacked against such an outcome.
What do we do about it?
Let’s zoom out and look at the weekly charts for stocks and bonds and to do so, we’ll look at the S&P 500 and TLT (20+ Year US Treasuries).
S&P 500 Index
Keep it simple. The S&P 500 has initiated a MACD buy signal (blue vertical line), it is above the trailing stop loss (green shaded line), and the RSI is not “overbought”.
Net/net, the S&P 500 has had one heck of a run of late and it may continue over the short-to-medium term until we see some of these indicators flip.
TLT
The same thing can be said for TLT.
TLT has initiated a MACD buy signal (blue vertical line), it is above the trailing stop loss (green shaded line), and the RSI is not “overbought”.
Net/net, TLT has had one heck of a run of late and it may continue over the short-to-medium term until we see some of these indicators flip.
Bigger picture, you should be asking yourself, “If the economy is super strong (i.e., sufficient enough to warrant a material move higher in equities), wouldn’t we be more likely to see Treasury yields rising and the Fed continuing to raise rates or at the very least, not talking about cutting rates?”
I think it’s possible that we’re in the last stages of equities making a final push higher before ultimately catching up to what the bond market is telling you which is that the economy is slowing.
So if you’re long equities, probably not a bad place to be for now, but remember to leave the party before the cops show up. And if after leaving the equity party, you’re looking for somewhere to go, the bond party looks like it is just getting warmed up.
Lastly, watch this week for Fed officials (or their unofficial mouthpiece, Nick Timiraos at the WSJ) to make statements that further walk back the possibility of rate cuts as J. Powell suggested last week. If that happens, the knee-jerk reaction will likely be modestly lower equities and modestly higher yields on US Treasuries (which equates to lower values on US Treasury ETF products like ZROZ, TLT, etc.)
Merry Christmas
There will not be a newsletter next week as I will be taking the week off to enjoy Christmas and spend time with my family.
This newsletter is dedicated to talking about markets but so often we get wrapped up in what the market may or may not do and we lose sight of what’s really important in this life which is family, friends, and faith.
My hope and prayer is that you will spend some time this Christmas season with friends and family and that you will tell them how much they mean to you because we are never guaranteed tomorrow.
With regard to faith, I hope you will indulge me by taking two minutes to read the following passage from the Bible, specifically, Luke 2:1-21, as this is the greatest story ever told.
If you’ve never heard this story before, or if you’d like to discuss it in further detail, never hesitate to reply to this email and I’d be happy to speak to you about it.
Merry Christmas and a Happy New Year!
The Birth of Jesus
2 In those days Caesar Augustus issued a decree that a census should be taken of the entire Roman world. 2 (This was the first census that took place while[a] Quirinius was governor of Syria.) 3 And everyone went to their own town to register.
4 So Joseph also went up from the town of Nazareth in Galilee to Judea, to Bethlehem the town of David, because he belonged to the house and line of David. 5 He went there to register with Mary, who was pledged to be married to him and was expecting a child. 6 While they were there, the time came for the baby to be born, 7 and she gave birth to her firstborn, a son. She wrapped him in cloths and placed him in a manger, because there was no guest room available for them.
8 And there were shepherds living out in the fields nearby, keeping watch over their flocks at night. 9 An angel of the Lord appeared to them, and the glory of the Lord shone around them, and they were terrified. 10 But the angel said to them, “Do not be afraid. I bring you good news that will cause great joy for all the people. 11 Today in the town of David a Savior has been born to you; he is the Messiah, the Lord. 12 This will be a sign to you: You will find a baby wrapped in cloths and lying in a manger.”
13 Suddenly a great company of the heavenly host appeared with the angel, praising God and saying,
14 “Glory to God in the highest heaven,
and on earth peace to those on whom his favor rests.”
15 When the angels had left them and gone into heaven, the shepherds said to one another, “Let’s go to Bethlehem and see this thing that has happened, which the Lord has told us about.”
16 So they hurried off and found Mary and Joseph, and the baby, who was lying in the manger. 17 When they had seen him, they spread the word concerning what had been told them about this child, 18 and all who heard it were amazed at what the shepherds said to them. 19 But Mary treasured up all these things and pondered them in her heart. 20 The shepherds returned, glorifying and praising God for all the things they had heard and seen, which were just as they had been told.
21 On the eighth day, when it was time to circumcise the child, he was named Jesus, the name the angel had given him before he was conceived.