FED TALK VS. THE STREET: WHO’S RIGHT?

February 3, 2024No Comments

Fed Talk January 31, 2023

 

(00:10): Today is February 1st when I’m recording this. Now you will be watching this probably about a week or so after I’ve recorded it. That’s okay. The message will still be pertinent. What I want to talk about today is the relationship between Jerome Powell’s Fed Talk speech, which was delivered one day before I recorded this. That was January the 31st 2024. And the overall message delivered by Powell was kind of a higher for longer tone. The market was originally wondering if rates would be brought down a bit and in other words, if the Fed would ease around March of this year. And the language coming out of the meeting the other day was decidedly more extended as far as the easing program goes. So I want to talk about some of the language that came out of the Fed and some alternative facts that economic statistics and the bond markets themselves may be differentiating from the Fed.

(02:00): So the Fed talk took place on the 31st as you can see here. And it was a higher for longer or hawkish kind of statement. Not truly hawkish, but keeping the rates where they are for the time being. And the question is how much longer? So the sum of the market participants out there were asking if the rates may not go up for well into the second half of 2024. And the question is, is that realistic? So I’ve put together some quotes that came right out of the chairman’s speech and asked if they are accurate in as far as economic reality versus what the Fed Chairman said. Oops, I’m just going to go back to that slide. So Powell noted in his speech that we are not looking for a weaker labor market, but the fact is household unemployment versus I should say household employment in the US to the end of the year.

 

Fed talk - Household employment chart

(03:09): This chart only goes to December 31st and was down quite a bit over the fall. Household employment has shrunk substantially. So if he’s not looking for a weaker labor market, well so far the evidence is he’s getting one Next statement. He said you hear things before they show up in the data. Sometimes what you’re hearing now is things are picking up a bit. Well, this is five of the major manufacturing indices and you can see here that they’re all, if you look on the right side of the chart into January, coming into the end of December, I should say they’re all down. So what we’re looking at is things are not picking up at this moment. They all deflected down in January. Now that’s just a month, but it’s something to consider. So Powell said we’re looking at financial conditions broadly. Well, let’s continue in that vein and look at financial conditions such as US bank lending growth to commercial outfits and companies in other words.

Fed Talk – Powell wants to keep to a 2% target

(04:18): And you can see that’s not been on an incline, it’s been on a decline. You can also see on the right side of this screen existing home shares, which are most definitely beginning to fall. So if we’re looking at financial conditions, IE home sales and mortgages and whatnot that go with it, US commercial lending, these are not going up. They’re going down. Okay, Powell wants to keep to a 2% target, which I had mentioned many times before is probably not realistic. This is just going back to 2004. So it’s not the 50-year history. The 50-year history is rates tend to be a little higher going way back, but even just since 2004 you can see that the belly of the move lies somewhere between at the low end and 3% at the high end. And we’re at that 3% point right now we’re at 3.14% according to multiple.com.

US Commercial bank Lending Growth

 

(05:20): And again, this would be not super up-to-date, but at least up to late 2023. Alright, so inflation in other words is coming down and is just about to enter into that sort of traditional say two 3% area, which is going to be probably meeting many of the fed’s objectives. The number 2% I think is less important than the direction. And so the market right now is calling Powell’s bluff. What I mean by that is that if Powell was talking about higher for longer, then why is it that the market has been looking for a forward rate cut of 1.4%, which is more the lower this chart is that means more rate cuts, the higher it is, means more rates rising. So if we’re looking at 1.42% average consensus on the street expected cuts, that’s lower than it was say back at the beginning of January.

CPI approaching historical range

(06:37): As you can see, there’s the beginning of January it came up and then it’s declined recently coming into this speech. So it’s not lower from the beginning of January. But what you can see is that it’s lower, at least coming into the speech. So whatever the case, the market has been anticipating that rates will be 1.4% lower by the end of this year. Now that’s a consensus view, it’s not an absolute. The TBI yield will tell us just as much. And you can see this is a three-year TBI chart of the yield not of pricing. And you can see the yield is down now to 5.4%, which is over the past week coming into the speech is much lower. So the TBI yield is falling even into the higher for longer vibe that was given during the Fed Talk speech. So let’s take a look at another chart.

The market calls Powell's bluff

(07:40): The bond market, which is possibly represented through the 20-year bond, you can look at the 30-year as well, but the long bond is spiking up coming into the speech. So leading in and the day of Paolo’s speech, the bond market price went up, which means yield went down. So this is another point that the market is not buying into the higher for longer tone that Powell’s speech gave. Now, by the way, I should disclose that this is the T-L-T-E-T-F of the 20-year bond and we at ValueTrend do hold a position. So on that topic, again, we hold the position. So we still hold a target of around 105 on the bond. Now two other targets could happen if rates do decline as much as I might be suggesting in this video. And that is 115 and 125.

20+ years treasury bond EFT re Fed talk

(08:50): These are just technical resistance points that could be touched. I’m aiming for 105 as my target, but it could go higher. And if you’ve taken my online course, you’ll know how to recognize if you should hold or not to see if it’s going to get to the next level.

20+ years treasury bond EFT

David Rosenberg is just quoting some statistics here. He says, as history shows, typically the lag from the last hike, the very last hike of a tightening cycle, which happened to be July of ’23 to the first cut is 10 months. So that would target somewhere around this spring in May or June for rate cuts. So in other words, what he’s suggesting is again, don’t buy into the higher for longer aka much later in the year potential for rates to decline.

(09:53): He’s using statistics here suggesting that we’re already going to be at that very normal historic point of reducing rates by early spring. How to interpret what we’ve just talked about today. We want to keep in mind that in the labor market, at least to the end of the year, we’re softening manufacturing indexes, as we saw are softening commercial lending. No surprise is softening. Remember, everybody’s staying at home to work these days. So commercial lending has been on the back foot, but home sales are also softening. These are all signs of a consumer that is backing off a bit. If you’ve looked at some of the other videos I’ve talked about discretionary stocks and consumer discretionaries, they’ve been softening.

Rosenberg on rates re Fed talk

(10:56): People are less likely to go and buy that expensive watch or snowmobile or whatever it is these days as they tighten their belts and as inflation eats into their budget to just buy groceries. So CPI meanwhile is approaching its historic range. It’s around 3% right now and that’s pretty much the top of the normal range that we should expect to see inflation. So there’s really not a lot of reason for, certainly not for tightening and even on holding off on easing, especially if we are seeing softening in some of those key areas that we just looked at. So the conclusion might be that rate cuts are inevitable based on the economy and just based on where CPI is and based on many factors, but when and so the historic hawked dove pattern suggests that May or June is when we’ll probably see our first cut, not August or something like that.

(12:00): So all that spells out that I’m bullish on bonds. I do think that the TLT that I own will probably go a little bit higher. And I’m not recommending you buy this specialty, I can’t make recommendations in this video, but certainly consider owning some bonds for your portfolio. Even Canadian bonds, although the story may not be quite so aggressive as far as when the easing happens based on the tones I’m hearing from the Bank of Canada. But whatever the case, I think that there’s some reason to hold some bonds in our portfolios, which wasn’t the case just a couple of years ago. There wasn’t a reason to hold bonds up until just over the past number of months. So we are in at ValueTrend and we have some belief that we’re going to see another 5% to 10% potential upside on the bond market. But of course, markets can prove you’re wrong.

 

That’s my take on the latest Fed talk.

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