FOMC on 3/22/23 - Why Fed Actions Matter More Than Usual

Research & Analysis
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I’ve been posting a bunch of shit on Discord and I want to take a moment to memorialize it here because it’s already scrolled off the screen there which means it’s dead to all of us. Plus we should all provide input on what we think next week could bring so we can make big bucks on FOMC like we usually do.

Leading into the rate hikes the primary agreement is that the Fed will raise rates until one of two things happen:

  • They have achieved a sufficient rate for them to hold until inflation and unemployment come to target levels
  • A financial accident, such as a major sector collapse, occurs that forces their hand in re-implementing QE

One mid sized and one major bank has encountered significant headwinds over the past week which makes the second bullet more likely than it was this time last week. Credit Suisse ($CS) has had issues for months now but that it came to a head so shortly after SVB puts the markets and the financial sector on the edge of their seats. Does this create an environment in which we need to worry about escalation? Possibly, possibly not. We have a surefire way of knowing but it’s going to require that we wait a week to see what happens.

Next week is FOMC, and my current perspective is that the expectations for us are flip flopped. Because we’ve been living in the inflation narrative, we’ve been conditioned to perceive lower rate hikes or pauses or reversals as bullish and the opposite is bearish. However, this time around, we’re looking to the fed to determine how scared we should be and their actions and Powell’s words will directly inform how healthy our economy and the global economy is now.

I posit the following hypothesis on FOMC day and the days that follow:

  • 25bps rate hike will be immediately construed as bearish and then JPOW will whisper sweet nothings in our ears. The markets will recognize that the fed’s willingness to continue to increase means that we are not teetering on the edge of significant financial stress and the markets will recover and react with bullish fervor for the following days.
  • Rate pause, will be immediately considered bullish, but
    • JPOW will probably provide caution on the current state of affairs and we may lose some of that. With additional uncertainty injected, the markets bleed for a few days as we remain in the “extreme fear” territory
    • JPOW will say that there is enough inflationary evidence that the rate hikes are sufficient enough to hold, and the market will rejoice knowing that we’ve hit terminal rates
  • Rate cuts are the worst case scenario for us. It would mean that the accident has already occurred and QE is back on the table, we just haven’t seen the worst of it. However, historically, rate cuts have resulted in some bullishness so we might get a nice rally until the markets process this

Curious to get perspectives on this. Seems to me like any longer position you take on the broad market before next Wednesday is over presumptuous and we should be playing day-to-day until then.

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Great post. I share a similar sentiment.

I am in the camp that inflation data has been proving inflation to be sticky hot and that the target of 2% inflation is far from being reached. Historically speaking, terminal rates have been in the range of 5 to 6%. How can something already be breaking when we haven’t even hit 5%? Looks eerie to me if fed cuts now because of something breaking.

I really liked your viewpoint on a rate pause, e.g. the two possible outcomes and how they might make sense to be bullish or bearish. I agree with it.

Here’s my view on the FOMC outcomes:

  1. 50 bps would be bearish because it would be a big hawkish surprise to the fed funds future, contrary to expectations only a week or so earlier. Some would argue that the inflation data suggests that 50 bps is the necessary move, but this could add further financial shock. All in all, 50 would be bearish and is not the expected outcome right now.

  2. 25 bps would be the most balanced between fighting inflation and acknowledging the recent bank risks. This is also the most “priced in” in the fed funds futures. This is the best chance for a truly bullish reaction, in my opinion.

  3. 0 bps AKA rate pause. Algo-wise could do a pop, and then depending on JPow commentary on why they paused would be bullish or bearish. Basically see Sucky’s post.

  4. Rate cut could get an algo pop too, but I see this is as very bearish because it means the fed is admitting the financial stress.

Some may argue that a rate cut or pause could also just mean that the fed is acknowledging that they overtightened and will now take their foot off the gas on the rate hikes. However, I don’t agree because of my take on the recent inflation data.

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re: sticky hot inflation https://twitter.com/jasonfurman/status/1635628309391507457

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Today’s ECB decision makes the likelihood of fears of a bank contagion lower, which means that there is a higher likelihood that stateside we will follow through with our own rate hikes as well. For the time being I have a bullish outlook in the short term. However, I cannot stress this enough, we are still day to day on this stuff. FOMC next week will still put a heavy focus on what Jerome says, and he could pull the rug out from under this bullish momentum we’ve got back from our 380 bottom just the other day.

Just as a point of advice I would be wary of near term short positions we have open on broad markets because it doesn’t seem in the stars that we collapse within the next week.

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