The Big Federal Reserve day has come and gone, and the markets are currently digesting the Fed’s policy shift. The statement itself was hawkish, but the Powell press conference seemed a bit dovish, especially concerning interest rate hikes. Twitter accounts calling it the good cop/bad cop routine or the hawkish chairman/dovish chairman routine. When it comes to rate hikes, the Fed is now planning on three rate hikes in 2022 post March 2022 when the taper winds down. Bond purchases are decreasing at a faster rate. Previously the taper was set to be finished by June of 2022, but now the Fed is aiming to withdraw support by March 2022.
The Federal Reserve began winding down its $120bn-a-month bond-buying programme in November, saying it would reduce the stimulus by $15bn a month. The stimulus will now be reduced by $30bn a month starting in January 2022. A move being termed as an aggressive dial back. The Fed will be buying $60 billion of bonds each month starting in January, half the level prior to the November taper and $30 billion less than it had been buying in December. Reduction in bond purchases will be accelerated as we head into 2022.
The uncertainty factor? Omicron and other variants, which could cause the cheap money to continue if we see more restrictions or even lockdowns.
The entire Fed meeting can be summarized by these three points:
The Fed doubled the pace of the taper to $30 billion per month
The Fed blames elevated inflation on “supply/demand imbalances”
The Dot Plot shifted dramatically, showing The Fed expects 3 hikes in 2022 and 3 more in 2023
Let me break some of this down. We have already spoken about the taper, however I am one of those that watch what people do rather than say. Enter the Fed balance sheet.
Above is the 3 month asset purchases. The Fed’s balance sheet still stands above $8 Trillion, and the trajectory still looks higher. The technical analyst in me wants to apply an uptrend with higher lows and higher highs. Just remember, the Fed is STILL buying bonds. This chart can show us how quickly they are. We will be more interested to see the trajectory come January 2022 when the reduction of bond purchases comes into effect.
Inflation is something I have warned my readers about since the Fed’s monetary policy began at the beginning of the pandemic. Once economies began opening up is when money velocity began to increase. Higher inflation was expected, and is still expected. The Fed and mainstream financial media are saying inflation is topping and it has to do with supply chain disruptions. Not a word about the amount of new money printed. I went into detail about this in my Gold post which came out today:
This brings us to the inflation question. The Fed is blaming supply chains, but we contrarians are saying it is because of the money that has been printed. We are in a situation where there is more money and people with more money competing for the same number of goods and services. Productivity is not increasing which is required for stable or little inflation when money supply is growing. I have told this story many times, but many people I know are trading. They have left their jobs and are now day trading and swing trading and making loads of money. Let’s be honest, we traders aren’t necessarily adding anything productive to the economy.
The worst case scenario for me is the Fed preparing to combat inflation…meaning they will have to raise interest rates very quickly in a short period of time. Currently, the Fed has told us this inflation was transitory…but not anymore. They have bought some time by saying inflation will persist into the second half of 2022. If inflation numbers remain elevated into next year…markets may begin losing confidence. Put it this way: the Fed cannot get ahead of inflation by raising rates to 1% if inflation is running close to 6%. They would need to raise rates above that, which would probably bring down the financial system. It would be biblical to be honest. Let’s hope that isn’t going to happen.
My definition of inflation has been with the monetary aspect. Inflation is when a currency is weakening hence it takes more of that weaker currency to buy something. Yes, there is some psychology behind it because if people believe the currency will weaken in a week or a month, they will purchase goods soon. This brings us to money velocity which has been a hot topic between Cathie Wood and Jack Dorsey. In a hyperinflationary scenario, people spend the currency right away because they believe they will be able to purchase less that day after. Money velocity is through the roof. Let’s hope that doesn’t happen, but I do expect assets to continue to move higher as people chase yield to beat inflation. Preserving purchasing power becomes key, which is why Gold is seen as the inflation hedge. To me, it is the best CURRENCY to hold. So if inflation is a currency weakening, you want to ditch fiat for non fiat assets. So let’s watch those CPI data prints going forward. If they come in higher, people will begin to doubt the Fed’s ability to combat inflation. Once again, if the Fed raises rates as much as they would have to, it would bring down the entire system
In a way that block from my Gold post also covered my thoughts on rate hikes.
The Fed’s dot plot is showing three 25 basis rate hikes in 2022 after the tapering. The real question is whether the Fed can even take interest rates that high given the government debt. Higher rates mean higher interest payments for the government. They can sell more bonds to raise funds, or they can increase taxes to bring in some more money. The latter could cause an economic slowdown itself if people cut down on spending, and did not borrow much due to the rate hike.
This is the slippery slope we are heading towards. The Fed needs to raise rates if they want to get ahead of inflation…provided they are wrong about inflation being temporary. Remember, they have admitted inflation will be here longer than they expected. If they kick the can further down the road as we approach the second half of 2022, I think the markets begin to lose confidence and realize the Fed will not be able to combat this inflation without raising rates to incredibly high levels which the financial system would not be able to handle given the record amount of debt. Fun times ahead, but this is why we are betting against the debt with non-fiat assets.
Speaking about fiat and non-fiat assets, the US Dollar chart has a few people scratching their heads. The dollar should have strengthened on a hawkish Fed. Instead it fell. Some will argue it is because the hawkish Fed was already priced in. Meaning the Dollar rise we have been seeing priced in yesterday’s hawkish Fed. If this is the case, the Dollar should be moving higher to price in a further reduction of bond purchases come 2022. But then this gets a bit tricky to spot when the Dollar can get a bid for being the safe haven currency during a risk off environment. The contrarians on the other hand, say this is a sign the markets are calling the Fed’s bluff. They are not expecting a significant taper nor rate hikes.
If you believe markets will drop on a taper because they are moving up as money chases yield due to easy money and low rates, the markets are pricing in no change. The S&P 500 rose and printed record highs overnight before selling off. If we can get a nice daily close above my resistance zone, then the trend continues higher. I also have to harken back to Stanley Druckenmiller saying the Fed is lulling investors into a false sense of security. Basically stating that Stock Markets will continue higher until the Fed ACTUALLY acts and does something rather than using words. Perhaps we need to wait for the Fed to actually raise rates for the markets to panic. But for now, let’s keep our eyes on that Fed balance sheet. As long as it moves higher, I continue to buy stocks, and we should expect to see more record highs.