Could a hawkish rate cut rattle markets?

Preface: Explaining our market timing models 

We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Asset Allocation Model is an asset allocation model that applies trend-following principles based on the inputs of global stock and commodity prices. This model has a shorter time horizon and tends to turn over about 4-6 times a year. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can be found here.

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don't buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the email alerts is updated weekly here. The hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.

 

The latest signals of each model are as follows:

• Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)*
• Trend Model signal: Neutral (Last changed from “bullish” on 15-Nov-2024)*
• Trading model: Neutral (Last changed from “bullish” on 03-Dec-2024)*

* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends. I am also on X/Twitter at @humblestudent and on BlueSky at @humblestudent.bsky.social. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of those email alerts is shown here.

Subscribers can access the latest signal in real time here.

Stubborn inflation

Investors heard some good news and bad news from the inflation reports last week. The good news is monetary policy is still too tight. The Fed Funds rate (black line) is too high compared to core inflation metrics and need to fall. The bad news is inflation progress to the Fed’s 2% appears to be stalling. Inflation is facing a last-mile problem of getting to 2%. 

This environment is setting up conditions for a hawkish rate cut at the December FOMC meeting. While the Fed is widely expected to cut rates by a quarter-point, it is also likely to signal a slower pace of future cuts.

 

The full post can be found here.

Near term volatility ahead, but don't fret

Is the U.S. progress on inflation a case of two steps forward, one step back? Even before the stronger-than-expected September CPI report, bond prices were declining in the wake of the Fed’s jumbo half-point rate cut decision.

The Treasury market is exhibiting signs of anxiety from a technical analyst’s perspective. The 7–10-year Treasury ETF (IEF) has declined to test a key rising trend line. The long Treasury bond ETF (TLT) has already violated its trend line.

While the technical violations may only be temporary false breakdowns, these technical signals compel me to explore their asset return implications.

The full post can be found here.

Positioning for Trump 2.0

In the wake of Biden’s subpar debate performance and the assassination attempt on Trump, the prediction markets’ odds of a Trump victory in November have substantially risen. Equally important is Wall Street’s reaction, which has investors sitting up to take notice of the implications of a second Trump Administration in 2025.

Despite the real-time information from the betting markets, financial markets haven’t fully discounted the possibility of a Trump win. Here’s how you can take advantage of that arbitrage opportunity.

The full post can be found here.

Transitory disinflation in 2025?

The closely watched April PCE moderated as expected. Headline PCE came in 0.3%, in line with expectations, while core PCE was 0.2% (blue bars), which was softer than expectations. Supercore PCE, or services ex-energy and housing, also decelerated (red bars). This latest print represents useful progress, but won’t significantly move the needle on Fed policy.

The worrisome development is the global trend of transitory disinflation. The Citi Inflation Surprise Index, which measures whether incoming inflation data is beating or missing expectations, is bottoming in most countries and rising again. If this continues, any expectations of ongoing rate cuts are likely to be pulled back.

Now that 2024 is nearly half over, it’s time to peer into 2025 to see the upside and downside factors that are expected to affect inflation and the Fed’s interest rate trajectory. The three main factors to consider are changes in immigration policy and how they affect employment; the evolution in productivity; and the possible political effects of the election on inflation.
 

The full post can be found here.

Are we in for a 1970's style inflation revival?

When Fed Chair Jerome Powell spoke at a moderated Q&A last Tuesday, he confirmed the higher-for-longer message of virtually all other Fed speakers: “The recent data have clearly not given us greater confidence and instead indicate that it is likely to take longer than expected to achieve that confidence [to reduce rates]”.
 

As a consequence of the shift to a higher-for-longer narrative, different versions of this ominous CPI chart have been making the rounds. Could we be in for a 1970s-style inflation revival?

 

 

The full post can be found here.

Looking for inflation in all the wrong places

Last week, I suggested that even though Fed Chair Powell voiced a balanced view of inflation, a voting bloc of hawks (Waller, Bostic, Barkin, and Bowman) on the FOMC may be a key obstacle to the market expectations of a June rate cut. Indeed, Atlanta Fed President Raphael Bostic reiterated his view last week of one rate cut in 2024 and the first cut should occur in Q4.

Based on the speeches of Fed speakers, a divide of opinion is appearing in the FOMC. On one hand, Fed Chair Powell has said that January and February PCE reports represent a bumpy path to the Fed’s 2% inflation target, hawks such as Governor Waller have raised concerns about the persistence of inflation and asked, “What’s the hurry [to cut rates]?”

As well, Chicago Fed President Goolsbee revealed that he wrote down two rate cuts for 2024 in his dot plot projection, which is a surprise as he has been regarded as a dove. Moreover, he stated that if inflation continues to move sideways, it raised doubt as to whether the Fed should cut at all. Minneapolis Fed President Kashkari also revealed that he wrote down two rate cuts for 2024, and also openly wondered if the Fed needs to cut if progress on inflation stalls.

Is it time to say goodbye to a June rate cut? What about the expectation of three cuts this year?
As a reminder, the Fed targets headline PCE as its main inflation metric. Both headline and core PCE rose in January and February after a series of tame readings in late 2023. The key question that concerns Fed officials is the last mile inflation question. How persistent is inflation and what’s the path to the 2% target? Investors may gain some insights from the FOMC meeting minutes, which are due to be released in the coming week.

 

The full post can be found here.

Is transitory disinflation here to stay?

I’ve discussed the risk of transitory disinflation before, and it manifested itself in the form of hotter-than-expected January CPI and PPI reports. The reports rattled the bond market and expectations of the first quarter-point rate cut has been pushed out from May to June and a slower rate cut trajectory for the remainder of year.

As a reminder, here is Fed Chair Powell reply in to a question about the timing of rate cuts in his 60 Minutes interview: “We just want to see more good [inflation] data along those lines. It doesn't need to be better than what we've seen, or even as good. It just needs to be good. And so, we do expect to see that.” 

 

The hot CPI report was undoubtedly a shock to Fed officials who had watching a series of tame inflation reports.

The latest BoA Global Fund Manager Survey showed that only 4% of respondents expect higher rates and 7% expect higher inflation. It was therefore no surprise that bond prices skidded badly in the wake of the CPI report.

 

Do the stronger-than-inflation reports mean a pivot to a “higher for longer” narrative? Here are bull and bear cases.

 

The full post can be found here.

The term premium red herring

About a week ago, market anxiety was high over surging Treasury yields, which was attributed to concerns over a soaring fiscal deficit and a rising supply of Treasury paper. This led to upward pressure on the term premium, or compensation for holding longer duration assets, and real yields.

 
Here’s what has happened since the peak in rate anxiety. In the space of a week, the market had to face a blowout jobs report, a surprise Middle East war, and hot PPI and slightly hot CPI prints. In the face of such news, one would think this would put upward pressure on yields. Instead, Treasury yields retreated.
The fall in yields was initially attributable to a flight to safety, but such an explanation doesn’t seem plausible as the USD Index fell in lockstep. If there had been a flight to safety, the USD would have been bid. 

What happened? The most reasonable explanation is that the jitters over rising term premium and real rates was a red herring.

 

The full post can be found here.

Is stagflation in our future?

Last week, I pointed out that the Citi Inflation Surprise Index was turning up around the world. While one month doesn’t make a trend, what if the Fed is making a different kind of policy error? Instead of over-tightening into a recession, what if the U.S. economy achieves a soft landing or no landing and the Fed is under-tightening and never achieves its 2% inflation objective?

The probable outcome of that path is stagflation.
 

The full post can be found here.

How the USD could sink the S&P 500

Correlation isn’t causation, but the USD Index has shown a close inverse correlation to the S&P 500. The relationship partly ended when the S&P 500 surged on AI mania. However, small-cap stocks, which are less subject to the enthusiasm over the AI revolution, maintained their inverse correlation.

 
The USD Index is approaching a key resistance level. Assuming the inverse correlation were to continue, what are the bear and bear cases for the USD, and consequently U.S. equities?

The full post can be found here.

The risks to the disinflation and soft-landing bull case

Ever since the softer-than-expected June CPI report, the Wall Street narrative has pivoted toward disinflation and a soft landing. The disinflationary trend had been building for some time and inflation has been surprising to the downside around the world.

 

 

 As a consequence, the markets have taken a risk-on tone in anticipation of less hawkish tones from major central banks. Nevertheless, I would like to sound a word of warning of the risks in the disinflation and soft-landing scenario. Investing isn’t easy, and seemingly bullish scenarios could easily shift at a moment’s notice.
 

The full post can be found here.

Does inflation matter to stocks anymore?

Mid-week market update: The S&P 500 roared out of the gate this morning on a slightly softer than expected CPI print. Robin Brooks observed that super-core CPI (core services  ex-housing and healthcare, light blue bars) have been decelerating.

Unfortunately for equity bulls, the gains faded over the course of the day.

Callie Cox pointed out that stock market volatility has been falling on CPI days when compared to FOMC and NFP days.

Does inflation matter to stocks anymore?

The full post can be found here.

A fire and ice challenge to risk assets

 In case you missed it, the 10-year Treasury yield fell and broke a technical support level even as the 3-month T-Bill yield rose. This left the 10-year to 3-month yield spread inverted further, which has historically been a strong recession signal.
 

  
The 10-year and 3-month Treasury yield spread has inverted before every recession. If history is any guide, a slowdown is just around the corner.
 

 

The stock market and other risk assets are facing a fire and ice challenge. Fire in the form of still overly hot inflation readings and ice in the form of a deteriorating economy.
 

The full post can be found here.

Between the Scylla of inflation and Charybdis of financial instability

In response to the recent financial turmoil, Fed Funds futures is discounting a 25 bps hike at next week's FOMC meeting, followed by a brief peak and rapid rate cuts for the rest of the year.

Are those market expectations realistic? How will the Fed navigate between the Scylla of inflation and Charybdis of financial stability and recession?

The full post can be found here.

Is there an inflation threat in your future?

On Valentine's Day, the European Central Bank tweeted a poem to underscore its commitment to fighting inflation.

The ECB tweet is also indicative of the tight monetary policy undertaken by most major central banks. Only two central banks, the BoJ and the PBoC, are meaningful suppliers of global liquidity. The rest are raising interest rates and engaged in quantitative tightening. While the Fed may be on the verge of a pause, last week's hot PPI report and slightly stronger than expected CPI print has raised doubts about a dovish pivot.

Inflation is becoming a threat again.

The full post can be found here.

The bulls cross their fingers for January

Mid-week market update: The bulls are nervously getting ready for a party. Jeff Hirsch of Almanac Trader pointed out that two of his January indicators are positive. When all three are positive, the rest of the year tends to lean bullish. 

This year, the market has eked out a 0.8% gain for its Santa Claus rally. The returns in the first five days has been positive. The only indicator left is a positive return for the month of January.

Will the bulls succeed? Here are the challenges they face.

The full post can be found here.

How inflation is a game changer for portfolios

In light of the dismal performance in the first nine months of a 60/40 portfolio in 2022, it's time to ask, "What's changed and what adjustments should investors make to their portfolios?"

The answer is inflation, and it's a game changer...

The full post can be found here.

A useful step, but where`s the clear and convincing evidence?

Mid-week market update: The markets took on a risk-on tone in the wake of the softer than expected CPI report. It was a useful first step and a possible sign that inflation is peaking, but I am still waiting for the "clear and convincing evidence" that inflation is under control before getting overly excited about the stock market. Managing monetary policy is like steering a supertanker. Changes happen very slowly and market sentiment may be getting ahead of itself.

The full post can be found here.

How to trade the hot CPI report

Mid-week market update: So much for the Cleveland Fed inflation nowcast which was calling for a tame CPI surprise. The market reacted to the hot CPI print this morning by adopting a risk-off tone, though it recovered later in the day.

For equity investors, keep in mind that the intermediate-term structure of the S&P 500 is a falling channel within the context of a positive RSI divergence.

Here is how I interpret the stock market's outlook.

The full post can be found here.

Green shoots = Time to bottom fish?

Now that the S&P 500 has started to turn up after bouncing off a head & shoulders downside target. Green shoots are starting to appear for the bulls, is it time for investors to buy stocks and bottom fish?

The full post can be found here.