It's Here...Fed Day! Let's Just Get A Move On Already.
1.) FED – Well, it’s here. Fed Day. Like some sort of anointed Biblical holy day. I would far prefer a decentralized market than a centralized, Fed driven one. But this is what we have. For several weeks now I’ve argued against a Fed rate hike and have given multiple macro reasons why I didn’t believe the Fed would deliver one. But, the market winds have changed some. Not in term of bullish to bearish, but in the way the market would likely receive a rate hike. Make no mistake, Fed chair Warsh is probably the most market-friendly Fed governor we’ve ever had. He is a markets guy. He worked at Stanley Druckenmiller’s (one of history’s greatest investors) family office. He grew up professionally in the markets, understands how they function, and understands exactly what can damage them. Before the last Fed decision, Citadel published what could be considered a hit piece claiming there was a 30% probability of a rate hike. I thought the probability was zero because raising rates would have crashed the market. That was the right view then. So, what happens now? Warsh will pursue what he considers the most balanced path for the Fed, interest rates, the economy, AND THE FINANCIAL MARKETS…with that last one being the major key point. I don’t know what he’ll do, but I’m guessing a 0.25% hike is now the path. Why the change? Because the markets are now expecting it, and Warsh will most likely choose the path he believes least damaging to markets and beneficial to the economy. According to JP Morgan, a 0.25% hike and no further guidance is the “inside” consensus. This move likely contains the longer dated yields (something the Treasury badly needs) and moves stocks higher. This move could push the S&P 500 higher by 0.25% to 0.75%. Another option is a 0.25% hike and remove the 2025 eases that were expected earlier in the year. If Warsh suggests the Fed could start taking back the 2025 originally expected rate cuts with raises in Oct and Dec, vs Dec and March, markets could view that as a vey healthy economy and seeing the S&P 500 up by 0.5% to 1% in that scenario would not be a huge surprise.
2.) OIL – Let’s consider the West Texas Intermediate (WTI) futures curve. The front month futures contract is $105, while the 2028 is at $71, and the 2036 tail is $51. It signals present tightness and future overcapacity. The key? Six months ago, the 2036 contract traded near $57. Today it is $51. Spot exploded, and the tail fell. The market still views the current oil spike as temporary, and the structural view of oil is weaker than it was in March. Steep backwardation like this (prices higher in the short term vs longer) means the physical market is short barrels today. That's a supply and geopolitics shock, not a demand boom. Sadly, that combination is the worst of both worlds for policymakers. Today's price destroys consumers' purchasing power and feeds headline inflation. Meanwhile, rate hikes would do nothing and are counterproductive. But again, Warsh will do what he sees as the least disruptive to markets…especially the bond and stock markets. And right now that is a small hike. This steep backwardation in the oil futures curve also means that once the disruption eases, the front may collapse toward the curve. If disruption remains, we get high prices and demand destruction. The curve is a dream for efficient producers and a nightmare for overindebted ones.
3.) GLOBAL DEBT – The UK, Japan, and France have the worst sovereign bonds in the G7. They wanted more government and higher taxes. They got weaker growth, wider deficits, and a demolished balance sheet. Debt is not free, and the bond markets are just repricing the bill. There is no such thing as free public spending. There is only deferred taxation and a rising yield curve (higher rates). The G7 is now paying both. Even though rates in the US have risen far less, the US needs to be careful that it doesn’t go down that same socialist style of public policy path. If it does, it will make owning longer term bonds worse.
