The Federal Open Market Committee (FOMC) did what it was expected to do yesterday and raised the Fed’s overnight lending rate by another 0.75 basis points.
That brings interest rates to a nice round number — 4%. Now, if you remember, back when the Fed finally started hiking rates to address out-of-control inflation, it was widely believed that moving rates from COVID emergency levels of 0 to 3.5% would probably get the job done.
Mine was one of the few voices in the wilderness that questioned that conventional wisdom. And here we are at 4% — and going higher.
Because the runaway inflation that Fed Chair Jerome Powell so glibly called “transitory” for a solid year before taking action has not responded to the Fed’s actions, at all.
You may have noticed that stocks initially rallied yesterday, after the Fed’s 2 pm press release announcing the 75 bp hike, and then sold off pretty hard during Chair Powell’s follow up press conference.
The Dow Industrials went from a gain of ~380 points to a 500 point loss for the day. That’s damn near a 900 point swing.
Here’s why it happened…
Powell Just Closed that Window of Opportunity
A little over two weeks ago, I wrote that there was a window of opportunity for the stock market to rally. And on Monday, October 17, I laid out three call option trades that would benefit from a rally. One of those trades returned 247% in just a couple days.
The reason I believed the market would rally is because it’s clear that cracks are visible in the U.S. and global economy. And since the Fed didn’t have the stomach to start hiking rates when inflation broke over its 2% mandate 18 months ago, I figured they’d probably cave when the going got tough.
Right on cue, a few Fed governors started talking about lowering the size of rate hikes, and perhaps stopping the hiking cycle altogether. And also right on cue, stocks started to rally and the Dow added around 15% through yesterday, the crescendo coming just after 2 pm when the headlines read “Fed Delivers .75 point Hike, Hints at Slowing Pace.”
Of course the three-quarter point hike was already baked in. But if Chair Powell was to confirm the rumors floated by his minions that the pace of hikes was about to change, well, that would be new information.
I watched as much of Powell’s press conference as I could handle. My blood pressure always spikes when Chair Powell starts in about how the Fed has been so diligent with its rate hikes, how they are so committed to fighting inflation, and they feel the pain of American families who are squeezed… because it’s utter bullshit.
If Powell had simply done his job, the Fed would’ve started hiking rates in March 2021, not March 2022. Inflation very likely never would’ve hit these ridiculous 8% levels and mortgage loans would still be affordable.
But he didn’t, it is and they’re not.
Powell did address the question of whether the Fed is thinking about lowering the size of rate hikes or pausing them altogether. And he acknowledged that he and his minions were thinking about this. But he said they need to see real evidence that inflation is falling.
And he went on to say that the Fed was also thinking that maybe the stopping point for rates is higher than what they’ve previously thought.
If you ask me, those comments are what prompted yesterday's 900-point reversal. And it doesn’t bode well for what the stock market does next.
Expectations vs. Reality
For the last couple of months, expectations have been that the Fed is targeting 4.5% as the stopping point for interest rate hikes. Yesterday’s move got us to 4%. But if you parse Chair Powell’s mush-mouthed comments, he said 4.5% is not the stopping point anymore.
And sure enough, this morning, Goldman Sachs says 5% is the new goal, by way of a 50 basis point hike in December, and two 25 basis point hikes early next year.
(Editor’s Note: Goldman Sachs is the Fed’s financial media voice. A Fed press conference is full of hemming and hawing, full of “could be this, could be that.” A Fed Chairman can never just come out and say what they’re going to do. Because saying something that they later had to backtrack on would be the same as an admission that they have no idea what they’re doing, that it’s all basically guesswork. And the Fed has to appear in control or all hell will break loose. So they leak stuff and let others float the trial balloon so they can see how the market reacts without being tied to the leaked info. CYA? You betcha!)
A 50 and then two 25 basis points hikes may not sound so bad. But lemme ask you this: how does a mortgage loan at 8% sound? And you thought the housing market looked bad now…
It’s gonna get worse. All credit is gonna get worse. But what if 5% interest rates don’t do the trick? After all, yesterday was the 4th time the Fed has whacked inflation with a 75 basis point sledgehammer, and nothing’s happened. And somehow magically the Fed is going to drop the 75 basis point sledge in favor of 50 basis point mallet, followed by a couple taps with a 25 basis point rock hammer, and that’s going to move inflation lower?
What I'm Buying
The Fed lost this inflation battle 18 months ago when it failed to act. If I were a betting man – which I am – I’d wager the Fed won’t/can’t stop until rates are at 6%. And I’d also buy some at-the-money put options on Bank of America (NYSE: BAC) that expire in a week or two – which I just did.
Take care, I’ll talk to you tomorrow
The Profit Sector