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Brainstorm: FOMC Thoughts and Market Ideas
Taking a step back and looking at the big picture
This week, I've taken some extra time to simply think and read. The peculiar thing about markets is that they draw you in to such an extent that you often forget to step back and reflect until you take a large loss. I've improved at taking a step back to think before taking large losses but it’s always easy to fall into.
The one thing I've enjoyed most this week is reading this book:
I haven't finished it yet, but it's proving to be an engrossing read. Whenever I take time away from the noise and immerse myself in any kind of reading, it helps me to be more patient and thoughtful in all my actions. The way you approach the little things impacts how you do everything. So, when I'm intentional in this area of my life, it naturally permeates other areas.
To be honest, these days, I find myself more inclined to discuss concepts or books I'm reading, rather than specific trades. Not to worry, though—let's dive into some particular trades and observations I've made!
Let's zoom out a little:
First, don't forget to frame where we are. We're nearing the end of the hiking cycle. This is evident in inflation, the Fed's rhetoric, the pricing of the forward curve, and broad price action.
We're experiencing a tension where CPI recently surprised to the downside, but growth data has remained resilient. Market pricing has also mirrored this reality. This is a tension Powell has highlighted and why there's still a reasonable probability of an additional rate hike from here.
Why is this growth and inflation tension significant? Simply put, if growth remains resilient, it creates the preconditions for a higher probability that inflation might marginally reaccelerate.
Two things I found interesting in Powell's comments today:
First, he mentioned he doesn't see inflation hitting 2% until 2025. I'm somewhat skeptical of this. I believe inflation could certainly hit 2% in 2024 if we experience a recession. I also think inflation could marginally reaccelerate if the labor market doesn't deteriorate in the next 3-4 months.
Second, Powell indicated their expectation is that they no longer see a high probability of a recession. I'm not entirely convinced by this either. Here's the thing, we can't know for sure, but when real rates are this high and the same structural forces are exerting upward pressure on unemployment, I believe we need some kind of growth scare at the very least.
One helpful caveat to remember is that a lot of inflation's impact on the market right now is more about HOW FAST inflation will come down. You don't need a PhD to look at this chart and say, "Yes, core inflation is decelerating."
The question at hand is: HOW FAST will inflation fall? Why does this matter? Well, because inflation is directly connected to the time value of money, which in turn is linked to market timing.
When we examine the pricing of the forward curve, it's about WHEN cuts will occur, which is dependent on the SPEED of inflation decelerating:
Remember when Powell mentioned that they're considering ALL data points holistically? It's because they don't want to enact preemptive cuts. If they cut preemptively, even if CPI is well below Fed funds, it could lead to a reacceleration of inflation. This is why the growth side of the equation is so vital. I believe the Fed could cut if BOTH inflation and growth are falling.
Here are a few observations from today:
Interest rates moved down marginally alongside the DXY. This continues to demonstrate that FX positioning is still moving in lockstep with duration positioning:
Secondly, we've observed a marginal rally in gold. This indicates to me that the rate of change in real rates is decelerating slightly as liquidity remains somewhat loose:
Cross-currency basis swaps have continued to rally with gold as well. All of this biases me to be marginally bullish gold.
As for equities, I believe this is a paradise for alpha generation. If you're seeking a TON of truly legitimate single-stock opportunities, I would recommend keeping an eye on Said Solomon and Citrini7 on Twitter. Both are legit guys that I have a lot of respect for. They have been calling the equity rally really well.
The other tool I use a lot is the ConvexValue Terminal because I like stacking some type of option flow edge with a macro view. They just released a new version of their terminal and it’s absolutely awesome:
The T1alpha ranges have also been incredibly helpful for mapping intraday mean reversion in SPX:
If we are just looking at things in terms of basic levels, here is how I view ES right now:
Until I see FX vol and credit risk spike, I am not bearish equities. However, I would rather play individual names like Said and Citrini than just get outright long the index. From a macro perspective, expected returns for equities are pretty low from here but that doesn’t mean much until liquidity conditions shift.
The one thing I am watching closely is oil and Ags. They are rallying considerably right now and that could eventually feed into headline CPI. I did a charts edition article yesterday that provided a lot more visuals for these ideas:
There are a lot of great opportunities out there right now but everything comes down to execution and trade construction.
I was talking with a subscriber the other day about the importance of trade construction. If my hit ratio is around 50%, then the way I construct my trades and manage my risk becomes THE determining factor in making money. I know traders who literally know nothing about macro but are extremely proficient at constructing asymmetrical trades that work in multiple scenarios. This is the goal!
The guys at Mythic Market have written some great articles on this:
The main thing I come back to at the end of the day is maintaining adaptability as opposed to a specific view. Adapt or die!
Thanks for reading!
In the information age, you simply need to be at the right place, at the right time, with the right information to succeed