It’s only 25 basis points!

Happy Friday!

I enjoy laughing at day traders, but that’s not because I think trading is stupid and/or doesn’t work. You absolutely can make money trading markets. It’s just really hard to do it consistently. That’s what I wrote about this week – what it takes to be a trader.

The short version is that while it’s easy to pick up a basketball, not everyone can make it to the NBA. 

The big news of the week was the Fed meeting, which should tell you that very little happened this week. Pundits seem to still be focused on rising interest rates, and I’m not sure why. I’d say there’s a 50/50 chance that I turn 50 before rising interest rates have any material impact on the economy (currently 44.5 years old). Here’s why:

  1. The Fed needs to signal their plans to taper its monthly purchasing of $120 billion in bonds (that’s a HUGE number by the way). My guess is they’ll casually bring this up sometime in the fall.
  2. The Fed then needs to taper these bond purchases. This won’t happen overnight. My guess is they start tapering early next year and go very slowly.
  3. The Fed then needs to signal to the market their intent on hiking rates. Based on the meeting this week, this probably won’t happen until 2023 at the earliest. 
  4. The Fed will only raise rates initially by 25 bps. They will then wait many months (maybe even longer) before the next hike.
  5. It takes about a year for a rate hike to make its way through the economy – mostly because it’s a big economy with a lot of moving parts, banks usually don’t push up deposit rates right away, etc.

Oh, and don’t forget that all we are talking about is a 25 basis point hike. In all seriousness, what is 25 bps going to do – good or bad? 

Now, I’m sure the pundits would push back on this timeline and say something like, “You’re forgetting about inflation! The Fed won’t have a choice!! Otherwise it will be the 1970s all over again!!!”

As we’ve discussed ad nauseam, secular inflation around 2.5%ish – 3.5%ish is likely. But the 8%ish inflation we’ve seen so far this year is temporary. It just is. Take a look at what happened this week to commodities. Lumber is down over 40% since its May peak. Copper, iron, cattle, you name it. It’s all coming down. Now, most of these will probably remain higher relative to 2019/20, but not 4x higher.

But even if inflation were to remain at current levels, it doesn’t matter to the Fed. They see it as transitory, and they’re in charge, so it’s transitory. It’s that simple. 

Since the financial crisis, the Fed has consistently whined about not having enough inflation in the economy despite tuitions, health care, groceries, sofas, airfares, hotels, cars, housing, and literally every other expense on the planet rising from the financial crisis to COVID. All that time, the Fed kept telling us inflation was between 1% – 1.8% each year (the Bernanke/Yellen years were especially laughable).

I even went on Fox Business News maybe 5 years ago and shredded the Fed (impromptu shred… was on the program for other reasons). I told the anchor that I thought the Federal Reserve simply must have the best healthcare plan in the country. They must cover 100% of the premiums, and any bill must get magically paid before Janet Yellen or any one of the thousand PhDs working there sees what it costs to stay healthy in the greatest country in the world. The Fed must also have an amazing cafeteria that is open 24 hours a day, delivers all food and groceries to their homes (rents and mortgages obviously paid by the Fed), and no bill is ever sent to an employee. Because there was no way otherwise that this group of geniuses could collectively believe inflation was below 2% (especially for retirees).

Back to present day… The Fed has kitchen sinked this one. Meaning, they’ve literally thrown like 19 different reasons out there as to why they can’t raise rates anytime soon. So, even if one or two of their excuses prove to be wrong, they’ve got a litany of others out there to hide behind. 

And their golden goose is the other half of their dual mandate – employment. They want to see employment improve, and for the first time in 40 years, they’ve told us that they are willing to let inflation run higher if necessary to get employment to where they want it. 

The reason why this is so powerful for the Fed is because headline employment numbers are borderline useless. You have to dig deeper, and this is precisely what I see the Fed doing for the next couple years. I’m expecting something like this:

  1. The unemployment rate falls below 5% (or 4% or whatever)
  2. The Fed then tells us that the participation rate and U6 number (people who want to work but gave up and left the workforce) is still too high
  3. The U6 number improves
  4. The Fed then tells us that all the gains have been in white collar jobs and we need to see improvement across the board
  5. Manufacturing, restaurants, and other jobs improve
  6. The Fed then points to income inequality issues that were exacerbated over the last several years (ironically this will happen because of Fed policy but whatever)
  7. And so on…

It may sound like I’m exaggerating here but I don’t think it’s that far off. The Fed has ZERO incentive to reverse course right now, and they have been abundantly clear to this point.

But that’s just my take. I could be wrong. This meme seems to think so:

Enjoy the weekend…