Today the fed raised rates by 0.75%, bringing the federal funds target range to 1.5% and 1.75%. In Powell’s speech after the initial decision, he said that the “next meeting could well be a decision between 50 and 75”, shutting down any expectations investors had of a full percent or greater hike – for now at least.
Our short-term trade from two days ago worked out, as the SPDR Gold Trust rose up over 1.5% and the Nasdaq went above 2.3%. Our rate prediction didn’t happen, but markets rose regardless because buyers felt safe to renter the market after a horrid couple of days of uncertainty. We closed our positions soon after Powell began his remarks, as both gold and the Nasdaq began to pop.
Where do we go from here?
We believe that there is a high probability of increased speculation of future rate cuts as economic data coming out in the next days and weeks will likely show signs of a sluggish or declining economy. We remain heavily in cash, with our main position being options on the SPDR Gold Trust. We believe that the worries of inflation will be taken over by worries of an imminent recession. The Atlanta Fed issued new real GDP estimates today, with a forecast of 0% for Q2 GDP quarter-on-quarter, which would follow the -1.5% decline in Q1. What will the fed do when investors set their base case expectations to be a recession within the next 12 months or earlier?
It would be no surprised at all to us if it was a last minute decision to change from a 50bps hike to a 75bps hike after seeing the markets expectations change in days as a result of the CPI report. They couldn’t look weak on the inflation front, so they gave the market what it wanted, but that was likely just a way to temporarily calm markets. They certainly do not want this hike to be a precedent for more 75bps hikes, as Powell was quick to suggest the next decision would not be over 75bps. Since we already believe that the fed is trying its best to keep rates as low as possible while also making markets think they have inflation under control, we believe that they will switch to be more accommodative as soon as they get the chance. A recession is that chance.
The fed, like the rest of the market, is looking backwards rather than forwards. It often takes Wall Street consensus a while to catch up with reality, and this is a prime example. As Druckenmiller pointed out earlier this week, there has been no other time in recent history that the economy has been in this situation – there is no precedent to it. Powell, the fed, and the market are struggling to grasp what is actually going on and it shows.
Going forward, we think that the most likely outcome within the next year and a half is that Wall Street becomes more and more concerned with a recession, which will temporarily take away fears of inflation. Investors will equate a recession with lower prices, forgetting that the recession was created by the inflation itself. We see the fed hiking a couple more times, before calls for a pause in rate hikes and quantitative tightening due to a looming recession overshadow calls for more hikes due to inflation. To position ourselves for this situation, we are long gold and short the dollar. Our position could easily change if economic indicators show a different reality than the one we see as most probable, only time will tell.