The Weekend Edition # 127 - Cuts are a go!

Welcome to another issue of the Weekend Edition!

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Here's what we cover

• Market Recap - When Doves Fly

• Macro - Cuts are a “go”!

• Closing Thoughts - Bubble burst or Even out?

• Calendars

Market Recap - When Doves Fly

March 18 - March 22, 2024

What an interesting week with Central Banks dominating the theme. Overall, the theme was dovish. While the Bank of Japan made a historic move to hike rates, the discussion on maintaining their level of bond buying at ~6 trillion Yen, seemed to fuel equities and continued putting downward pressure on the Yen.

The Fed maintained their projections of 3 rate cuts this year and the Bank of England held rates, while the Governor later said that rate cuts were on the table at every meeting going forward. The Swiss National Bank went ahead and made an unexpected cut.

No doubt the reaction to the Fed was a celebration and frenzy of equity buying as treasury yields came under pressure. Equities took a breather on Friday, brought further down by consumer companies - Nike and Lululemon. This was a continuation of the retail theme that we got last week with several companies lowering guidance for this year.

We saw Reddit soar on its debut on Thursday and the word on the street is that IPOs and speculation are back. Not altogether surprising given the market is getting ready for the Fed to cut rates and taper their balance sheet run-off which will, undoubtedly stabilize liquidity in the market. Friday had an ugly close.

Despite the Fed's dovishness this week, the US Dollar held quite firm for the week. We saw the US Dollar rally into the Fed meeting as the market started to lean into the idea that the Fed was going to hold rates higher for longer but eventually, it gave up its gains as the Fed meeting progressed. Nevertheless, countervailing forces have now seen the dollar strengthen again, as a weaker Japanese Yen, Swiss Franc, and British Pound continue to prop up the USD.

Commodities

Commodities have continued to rally since the beginning of the year. The CRB commodities index has seemingly inflected and what we continue to see is an upward rally in prices.

Gold had a smashing week, gaining further ground after a period period of consolidation. The Fed’s rate cut projections seemed to have given it the boost it needed to continue on its next leg higher. Interestingly enough, the correlation between gold and the Swiss Franc has broken down here.

Managed Money Positioning as reported in the Commitment of Traders report seems to suggest that there is still room to the upside in Gold here.

Some of the charts in the recap section have been sponsored by Koyfin. We have a special discount of 15% for MacroVisor readers for any new sign-ups to Koyfin. To take advantage of this promo please sign up here - Koyfin MacroVisor Discount

Macro - Cuts are a “go”!

We expected the Fed to continue projecting three cuts during this meeting because we expect them to retain that optionality in an election year.

What we didn't expect was the Fed Chair being so dovish in the face of stickier core inflation and rising headline inflation.

The Fed has certainly lowered the threshold to begin cutting rates:

1. They increased the GDP forecast signifying a stronger economy

2. They increased the inflation forecast to 2.6% from 2.4% accepting a higher level of inflation for the year

3. They reduced the unemployment projection to 4% from 4.1%, which is just 0.1% away from the current 3.9% unemployment rate.

Taken together, all three conditions make the path for the Fed to start cutting rates much easier. At this stage, the Fed seems content to shrug off the reflationary scenario in the economy and focus on reducing the cost of borrowing, particularly for the government and big businesses.

The US Treasury has been issuing bills (shorter-term debt) to be able to keep up with the enormous level of fiscal spending being undertaken by the US government. Ordinarily, you would find a situation where the Treasury would be issuing longer-term debt to match longer-term spending plans.

However, with the inverted yield curve and the aggressive hiking from the Fed, we have a situation wherein Money Market Funds were earning higher if they parked their money in the Overnight Reverse Repo with the Fed.

So the US Treasury almost had to issue more debt at the short end, which is earning a higher level of interest, making it comparable and at least, lucrative for the MMFs to buy up this shorter-term debt. As a result, the US Treasury gets its financing.

Last week I talked about the Fed having 840 billion reasons to cut rates, because that is the projected level of interest rate expense on US Debt for the year, i.e., $840B. With the backdrop of fiscal spending, keeping rates higher for longer makes it very expensive for the US government to keep spending the way they currently are.

The US Government now has over $34.5T of debt, which amounts to ~123% of GDP. This was 59% of GDP in the year 2000!

As much as we would like to think that the Fed is an independent institution, we can’t help but wonder whether this gap called “Net Interest Outlay” has something to do with the Fed cutting rates.

Closing Thoughts - Bubble burst or Even out?

While I think we are seeing an AI bubble here, we’re not seeing an everything bubble and that’s what could potentially make a difference in this market. But, in order for this AI bubble to not bring the entire market tumbling down, what we would need to see is for the market to broaden out.

Easing of financial conditions, because the Fed is ready to start its policy normalization, could lead to other companies catching up to the big tech companies. Conversely, we could also see a slowdown in the big tech and euphoria-driven names so that the market meets somewhere in the middle.

This is one reason that even though we’ve crossed 5200 on the S&P 500, a few of the banks continue to hold on to their target around this level because they assume that the market will balance out instead of rallying further. There are, of course, others who model the S&P 500 at 5400 and more recently SocGen came out with a target of 5500.

Have a great week ahead!

Sincerely yours,

Ayesha Tariq, CFA

There’s always a story behind the numbers.

Calendars

US Earnings

US Economic Calendar in Eastern Time (Source: Trading Economics)

None of the above is Investment Advice. I may or may not have positions in any of the stocks or asset classes mentioned. I have no affiliation with any of the companies other than explicitly mentioned.