Fed Day: Ball Don't Lie
"Ball don't lie!" - Rasheed Wallace
“Ball don’t lie!” – Rasheed Wallace, New York Knicks
Fed Day – a day I look forward to every 6 weeks. As a firm believer in free market capitalism, there is a part of me that always hopes that the Fed comes out and says something the market is not expecting. Better yet, the Fed says or does something that actually makes the market listen rather than continuing to call their bluff as history has shown.
My belief as a free market capitalist is that the Fed and all other central banks should never project what they expect to do. I believe that markets should be free and should benefit those who can see the things that others don’t, as our current system creates moral hazard. With that being said, whether I agree or disagree with markets doesn’t matter, what matters is making money so for the time being I will continue to utilize the information given to me and make my bets accordingly. Just like Rasheed Wallace said in 2012 before getting ejected, “Ball don’t lie!” and in this case, the market and the Fed are the ball.
For transparency, I am positioned for an increased level of volatility following today’s press conference at 2:30pm EST, but I am also hedging my bets by remaining long some high-beta stocks. Worst case scenario, stocks sell off and my hedges provide a healthy level of protection for my portfolio. If stocks move higher, my hedges, which were put on using options, will end up worthless, but overall my portfolio will move higher due to the nature of stocks that make up my trading portfolio at this given time.
What I look forward to on Fed Day is parsing through the economic data and/or market-moving news that has come out since last meeting. My goal is to leverage this information to speculate on the reasons behind any changes in the Fed’s position, comparing these changes to previous meetings.
In the last meeting on January 31st, Jerome Powell, Chairman of the Federal Reserve, made it clear that the Fed would remain data dependent – a la he said nothing new. Here are some details from the last FOMC meeting on January 31st, as well as some things to note going into today’s meeting:
Rates Unchanged: Last meeting, the Federal Open Market Committee (FOMC) kept the Federal Funds Rate (FFR) unchanged at 5.25% - 5.50% for the fourth consecutive meeting.
Employment: FOMC members stated that the continuous, steady growth in jobs are moving in a more consistent manner with a pace that will help the Fed achieve their 2% inflation target.
Inflation: As stated above, employment growing steadily has given the Fed more confidence that they will be able to achieve their 2% inflation target. One of the most pressing inflation data points is wages, thus as job growth expands, inflation follows and lags the newer, higher wages set by the market. Make note of this as Jerome Powell speaks today because the Fed’s biggest fear is “sticky” inflation i.e. people making too much money for too long, moving the standard wage higher.
Rate Cuts: As of 1pm today, the market expects the FFR to remain unchanged for the fifth consecutive meeting. Currently the market is pricing in a 60% probability of a 25bps rate cut in June, while only giving May an 8% chance of a Fed rate cut. Image below of June expectations for rates, which comes from one of my favorite resources - CME Group’s FedWatch Tool.
Commercial Real Estate: After New York Community Bank’s (NYCB) horrific Q4 results, stating serious distress in the commercial real estate market, keep an ear out for Powell’s comments about the RE market especially if he hints at effects spilling over into the residential market. Commercial RE is approximately $20tn depending on what source you use, which is massive, but it is still only about 20% to 25% the size of the residential RE market in the US. It is no secret that commercial real estate is facing serious issues, but the result of what happens in commercial real estate is the biggest unknown to the market. If the rest of the economy can remain resilient, that may lead to a reset in commercial RE without ripple effects, but if the rest of the economy starts to slow down, commercial RE is large enough to add fuel to the fire.
Market Levels: Although the Fed states that they do not care about stock prices, they do care about financial stress or “tightness” in the market. In other words, the Fed may not directly care about stock prices, but they are entirely aware of the effects that market levels have on consumer spending, optimism for the future, and so on. The reason I am paying attention to Powell’s comments as it relates to markets is simple: he learned in 2018 that shocking the market would create market volatility, which he does not want. Whether I agree with that sentiment or not does not matter, but what does matter is Powell’s words. He has been known to quietly hint if the Fed is going to pivot, which all of Wall Street is aware of, but it is less obvious for those not in the industry. Pay attention to how he speaks about things like “optimism”, the ability for companies to receive funding (IPOs, debt issuance, etc.), and corporate debt levels.
Corporate Debt: For those who are unaware, Jerome Powell comes from the world of credit and he was exceptional at what he did. Powell understands that credit dwarfs all else so his focus on consumer and corporate debt has stood out compared to the academics who have been in his seat previously. Powell is aware that corporate junk borrowers took on a lot of short-term debt when they got caught off guard with the fast rate-hiking cycle in 2022. He is also aware that the junk debt they borrowed to cover short terms cash needs are coming due over the coming 12 – 24 months. He is also highly aware of the amount of variable rate debt that was taken out by consumers when housing prices soared and consumers all of the sudden had access to ample dollars from HELOCs and HE-Loans.
Depending on your experience in markets, what I have stated above may come across as overwhelming or it may read like everything else you’ve read today. My goal is not to tell anyone what they do or don’t know, the only goal I have is to articulate what I am paying attention to. As such, the focus for me today will be on corporate debt and commercial real estate. I don’t expect much from the corporate debt side of things because as I’ve said before, Powell does not want to overwhelm markets or portray a bleak outlook.
After the press conference today, I will write my notes as usual and then read the transcripts from the meeting this evening. If and when I do, I will write a brief follow up piece if there is anything to note. If not, I hope you all have a great Fed Day and look forward to publishing another long form piece tomorrow or Friday.