S2 E2: What Does the FOMC Know, That the Markets Don't?

What Does the FOMC Know, That the Markets Don't? 

Alternative Title: "Jerome Powell goes Mandelbaum on the Market!"
 
Indeed, Jerome Powell and the FOMC stunned markets last week as the US Central Bank did NOT verbally "protest" the uber-dovish Fed Funds Rates "priced into" the futures market for end-2024 (roughly 4.50%, down from 5.00% in October), but rather went DEEPER and MORE DOVISH, with projections that put the FF Policy Rate BELOW 4% by the end of next year. 

The Fed went "Mandelbaum" on the markets..."taking it up a notch", like the famed supporting character in the US sitcom "Seinfeld", an 80-year-old workout guru and Jerry's personal trainer Izzy Mandelbaum.

But WHY?
 

With inflation at 3% to 4%, the 5.5% FF Policy Rate is "sufficiently restrictive", and thus right where they want it to be. Moreover, inflation remains sticky in many staples and embedded in housing and services. So WHY the DRAMATIC and abrupt 180-degree about-face in monetary policy?
 

Does the Fed know something the markets don't?

Perhaps, The Fed is moving to protect something other than the economy...maybe there is an issue with credit conditions and the BANKS?

Transcript

Small Banks at Risk of Credit Crunch

Polarized Play

Speaker 1 0:02

Hi, greg Weldon, back with you. Season two, episode two of money markets and new age investing, and we're coming off a week that was, frankly, historic. The way that the Fed did a 180 degree turn, a complete flip flop on policy, really has shaken the markets up. We're certainly going to talk about that in a minute, but as we lead into that, we have to first look at the backdrop against which the Fed made this decision, which really wasn't a decision per se as much as it was. Number one, comments that were dovish from Powell and number two, dot plot and projections out for the future that were more dovish than even the dovish market had been pricing, which is really what was the shot across the bow of the markets that started this big rally that we've seen over the past couple of trading sessions since the Fed meeting. We have to rewind to the inflation numbers. The Fed wants to declare war, declare victory over inflation. We could look at the fact that the all items index at 3.1,. You could look at the PCE index similar rates hovering around three. Three is not two, three is not victory if you're looking for two. Now what makes it interesting is that, relative to three, five and a half Fed funds is punitively restrictive, so they are beyond what they want to be, which is sufficiently restrictive to the point of being punitively restrictive on the economy. It's starting to show some signs. So that was kind of the logic, at least in my mind and the market's mind, as to why eventually the Fed would shift the narrative from fighting inflation to protecting the economy. But in the same vein, you have the core rate at 4%. You have energy, where energy commodities down 9.8% year-over-year. You have gasoline that is falling at the wholesale market below $2 a barrel, whereas a year $2 a gallon, whereas a year ago it was trading $2.17 and then properly rallied over the first seven months of 2023, the year just passed to over $3. So when you get to July of this year, the futures market pricing at two and a quarter. That's demonstrably below $3. What's the point? The point is the year-over-year negative impact on the inflation data from energy, from the simple base effect, comparing it to last year, is set up to remain a deflationary, disinflationary influence. But I would venture to say that most everyone listening spends more money on their mortgage or their rent per month than they do on gasoline. I would venture to say a lot of people, not everyone out there people that drive or salespeople for commuting or whatever and I used to drive an hour and a half each way to New York from South Jersey every day to commute to work. The dynamic around you spend more money on food in a month than you do on your gasoline. Surely, when you combine health insurance and automobile insurance, you spend more on that. So the places and the degree to which food at home is 8% of CPI, whereas energy is 4%. So I think the dynamic around how much energy is a component in driving the inflation number has to be taken into account. When we look at the core rate, which excludes energy, the year-over-year rate is 4%. It's been a 4% or higher for 30 consecutive months. I remember Powell and a whole bunch of people, including Janet Yellen, using the word transitory in 2021 when inflation rose and they said it would be transitory. Hello, transitory. What is transitory? 30 months does not define transitory, defines permanent. It defines embedded. It defines kind of almost unanchored, but just reminds me of the word transitory. I would also point out in terms of you know, is it safe for the Fed to declare victory over inflation? Well, they're not really declaring victory over inflation. They're basically saying that our policy rate is high enough relative to the decline in inflation that we can bring it down and still maintain inflation vigilance, still maintain a sufficiently restricted policy. But they took it a step further. And when they take it a step further when we look at some of the cities and cities report CPI every other month. So you know I love to track them because, hey, it's pretty simple, more people live in the urban areas and while this is urban CPI, when you look at the city numbers it really gives you a sense of what people that live in the most populous areas of the country are paying relative to the headline rates. And most of the cities are above the headline rates Miami, slash for Lord of the slash, palm Beach 7.4% rate of inflation. Dallas, fort Worth, 5.2. Tampa 5.2, denver 4.5, seattle 4.8, la 4.3, san Diego 5.2 and it had been above seven. The only place where you see any kind of disinflation or rates that are below the Fed's target of two is Alaska. In Anchorage, alaska, inflation is 1.1. So you know, if the Fed is talking to Alaskans, then they can declare victory over inflation. But there's more to it, because we could look at the report on retail sales in a variety of ways and the fact that retail sales produced a 4.1% year over year rate of change, which was higher than expected and higher than a month ago, has caused a feeding frenzy in the consumer discretionary stocks. So it's like you know anything. Any excuse here to be bullish on stocks is being taken as a, you know, as a green light. You know, in terms of green flag racing is back at the US stock market Speedway in the dynamic around retail sales 4% a year versus a year ago and this is what's being celebrated. The problem is you dig into the numbers, which is what we do here, when you see that last year from October to November, there was a 10.4 billion dollar decline in retail sales. So the decline from October November last year was 10.4. The increase this year is 1.9. That gives you a vastly overstated year over year growth rate relative to what the annualized rate of the 1.9 billion monthly number would be. So because of the base effect here, retail sales look stronger than they actually are. To be fair, retail sales for online shopping and eating and drinking establishments very solid, double digit growth, solid numbers. So you have something for everybody here. And you had the same thing in CPI had some disinflation and energy had some inflation in other areas. So, depending on which camp you're in, you had, you know, fodder in terms of data evidence to make your case. The XL Y breaks out not only on its own but against the S&P 500, which is probably the most important thing. But in terms of inflation, all right. When you have stuff like capacity utilization below 79 and down from above 80, you have import prices down for the second month in a row and 11 months down year over year. So some of that backdrop continues to kind of support this shift. All right. And in terms of the economy, all you got to do is take real retail sales Okay, basically retail sales, compared to the rate of inflation, you've been negative 11 months in a row and the most recent month was flat. When you talk about real wage growth average hourly earnings, average weekly earnings from the BLS employment situation report real wages down for deflation year over year for two years now two years and think about this San Diego inflation might have dropped from 7.6 to 5.2. It's still almost three times the Fed's target of 2%, but more than that. There's only two other times in the history of that data series, which go back to the 80s where you saw San Diego inflation above 5%, 1990, right before one of the most vicious recessions that I've ever experienced. And 2000, right before the tech bubble crash, big impact on the economy, when San Diego inflation above 5% is currently 5.2. So from that perspective you might say, well, powell had the justification to do what he did. But you would have thought that he would stay the course with the normal pattern of Fed meetings where they tell you that they're going to remain inflation-infidulent and they don't want the markets to be pricing and easing. And it's like a protest against the dovish pricing in the markets when Powell speaks. Well, his comments at the most recent press conference just last Thursday were very interesting. I'm going to read a couple of them to you. Verbatim Policy has moved well into restrictive territory. Well into that's a key saying. It might have gone too far. Even Economic growth has slowed substantially since the third quarter. Economic reason to stop tightening Activity in housing remains well below year-ago levels, well below well into GDP growth, expected to fall to 1.4 next year. Members did not write down any further hikes. That seemed necessary. When they say write down, they mean in their dot plot. The dot plot basically has a dot for each member. They project where they think inflation and growth and the Fed funds rate will be. And those are the dots, and that's the dot plot. And every member 19 of them has a dot. So you just see what the variations between various opinions are. It's really cool. It doesn't mean anything, it's not. You know, then, frankly, they're wrong, like all the time. But he says here we believe the policy rate is at or near its peak for this cycle. The question is, when will it be appropriate to dial back, policy restrain, aka cut interest rates? I mean, that's a total flip. And when you look at the dot plot, that's where things really get interesting, because the projections for the range of the Fed funds rate, the policy rate currently. Five and a half a month ago they were saying for next year it would be between 4.4 and 6.1, which would mean two more rate hikes, maybe even three, were priced in. Not anymore. There's no rate hikes priced in. In fact they are projecting the low end potential for Fed funds next year to be 3.9% below 4,. Even the futures market which the Fed has said we don't like where they are priced, when they're pricing in a four and a half four, 65 Fed funds at the end of next year. The Fed just projected a chance of a sub 4%. The Fed went mandelbaum on the market and said we're taking it up a notch, and this is shocking to me and really is the biggest thing to note here. This is not only no protest of the market's pricing. You went further than the market's pricing. You affirmed their pricing and then some, you have done the most abrupt and quickest and most dramatic 180 degree policy turn that I've ever seen outside of a crisis, and right away. That begs the question what does the Fed know that we don't know? I've had some experiences recently and I've talked to a couple of my friends who have had very similar experiences with their banks that are one day same day wire takes a day or two coming in and going out. I wonder why that is. Do you need the money to hold the bounce sheet somehow? I don't even know how that really theoretically works, but that seems to me that something going on just anecdotally. And then you get this from the Fed and you have to ask them to know something we don't know. Well, bank stocks rallied, so it can't be the banks right Wrong. They have shrunk. Thank you for playing. Yes, it can be the banks amid the deepest QT in Fed history 52 weeks they have shrunk their balance sheet by $843.5 billion, although that's 52 weeks, and yet last week the balance sheet expanded out of the blue, completely off track, rose by four and a half billion dollars in a single week. Why? Because of their term funding program. The term funding program is basically the emergency facility, as it's called, that the Fed set up in March to deal with the AVB banking crisis and the failure. You have this facility that banks, if they're having trouble, can go and borrow money directly from the Fed. All right, $4.8 billion last week. $15 billion over the last four weeks. In March it was zero. By April, as AVB and then even First Republic went belly up, it was $79.02 billion. By May it had gone down to $75.78, so some of that money came back in. But all of a sudden in November it started rising again. All right, in November, first half of November it rose to $109.07, and in the last four weeks it has risen to $123.76 billion dollars. All right, in May it was $75, now it's $124. That's a lot of money that someone's borrowed from the Fed One of these banks that suggest. You're kind of back in the AVB first Republic scenario, where somebody is having liquidity and or funding and or both types of problems. So I went to the Fed's commercial bank balance sheet numbers over the weekend. What I found was what I would call a tad disturbing. Small banks seem to be the ones in harm's way here. Deposit at small banks are down 25.7 billion over the last two weeks alone. Deposit at small banks in December of 2021 was 5.27 trillion. Deposit at small banks now 5.27 trillion. In the last two years, deposit at small banks have been flat lined, have not risen barely a penny. The only other time that we have seen this kind of dynamic was 2009,. Right ahead of the banking crisis, right ahead of a major credit crunch. I mean, you know. Not only that, but as deposits fell by 25.7 billion in the last two weeks, liabilities rose by 74.5 billion over the last two weeks. That's 100 billion swing, 100 billion negative gap there in two week period between deposits and liabilities. Not only that consumer loans all three of the major consumer loans credit cards, auto loans and revolving credit fell in the latest week. It's a credit, it's a credit tightening hat trick. All three fell. So that's interesting. So in that whole context, when you talk about this deposits having grown, you could say that in that same context, the 52 week change in deposits is minus 88.9 billion. So over the last 52 weeks, a 90 billion outflow. The peak meaning the trough of that move, was 187 billion back in April, but all of a sudden now you have minus 90 billion in deposits and yet loans are up over 250 billion. That's a 350 billion flip flop. Now these numbers are coming from very high levels both, and they've come down, but deposits, the growth has come down so much faster. That has the growth in loans. So in that same vein and here's where it gets really interesting At the same time, having built huge cash reserves during the pandemic, as deposits have started to decline, they're selling assets and all of a sudden, the cash reserves are falling. They're down about 50% from their peak in 2022. And cash reserves at small banks 415.3 billion, borrowing by small banks from the Fed to fund themselves 433.9 billion, and rising above cash reserves. That's a negative ratio that Fed is going to call problematic every day, all day, whenever they see it. The only other time we've seen this where you had cash reserves below borrowing was in a period from 2006 to 2008. That led to the banking crisis and you were at the highs. Where you are now is the highs in 2008. You're already there Now. This matters a lot more now in terms of the small banks, because in 1986, large banks accounted for 85% of the loans in this country to businesses and to consumers. Small banks were only 15%. That is completely flip-flop. It's almost even now Large banks 58% of all loans, small banks 42% of all loans in this country come from small banks. Small banks have a problem Everyone has a problem and it's credit availability. It's a credit crunch and that is the biggest risk from the Fed being too tight. Do we see where this is going? This is why the Fed just did what they did, and it gets worse when you take about the small banks and defining small is interesting because there's a variety of ways to do this but for these purposes, let's talk about the really small banks, which is under 10 billion in assets they consider small banks under 250, and then certainly the big banks are above a trillion in assets. But let's look at it from this perspective Below 10 billion really small banks they have one third 35%, actually over one third Of all the commercial real estate loans outstanding in the entire country are held by small banks, now Below 250, what would be considered small banks by the Fed. Theoretically, it's 80% of commercial real estate loans, but it's also the big banks Morgan Stanley, goldman Sachs, huntington Wells Fargo, bank of America and CFG, which is a really tiny bank which owns like it's like 35% of their total loans are in commercial real estate loans. These, according to their most recent Fed stress test, would be looking at double-digit losses If you had the expected rate of failure in CRE loans, 1.7 trillion of which you have coming due In the next 18 months. Think about that. I mean, holy mackerel, that's crazy, you know. So what do we do with this? Well, I mean there's, you know, really, this is a polarized play and it's old school hedge fund play. Long short, old school, old school hedge fund. The Q A, b, a is the community bank ETF, that's the tier three, that's the third level bank. Kre is the regional bank ETF, that's tier two, and KBE banks BR regional. Q is the community, the KBE is the tier one. Well, the Q A, b, a is breaking down against both other tiers the car, kre and the KBE. So the bottom line is to be short community banks and long the big money center banks. Within the big banks, though, you have this polarized situation too. You could even play it this way when you look, over the last 52 weeks, the performance in the stock stock price JP Morgan up 27%. New York Bank of New York, mellon up 17%, city Bank up 12,. Fifth third, up 10 versus the low levels and the low alpha. By the way, those are the high alpha stocks with the big returns, the losers truest, comerica and Key Corp. So, in that context, maybe you're buying the strength, selling the weakness, and I, you know I get again. It's a polarized, old school hedge fund play long short. I just did a special report with all of this information and break down on all these banks. Today, as I'm recording this, it's out to my clients. I'd like to offer you a copy of that complimentary copy if you want it. Sales at Weldon onlinecom. Weldon online one word, weldon onlinecom. So what's hot in the stock market right now? Well, we produce what we call the portfolio playbook, which is the New Age investing. Portfolio playbook is the direct derivative of this podcast, and what we have? You know, we run this quantitatively, run discretionary. You get my 40 years of experience. And what we started talking about a couple of weeks ago was the mortgage sector that mortgage rates would fall and even if inflation went back up and even at the Fed hiked again and even if Treasury bond yields rose which I didn't think they would and they haven't quite the opposite, made a ton of money in the bond market the last couple of weeks and short side of the dollar and the long side of some commodities. But when we talk about the hot sectors the mortgage sector for sure, the builders, for sure, construction, all the materials All right, and in terms of even the operations and management and REITs in real estate, this is going to be the hot area. I mean you have a fundamental supply imbalance. You don't have enough homes and when mortgage rates start to come down, you have the supply side tightness. You're lacking the demand right now because affordability has been a problem. When that becomes, when that changes and it will and it's going to happen, not to this in future housing is going to be hot, inflation and home prices will skyrocket. Some people will be left out, polarizing based on wealth again all over. But the bottom line is you see the reaction already in the home building shares. I've been recommending them all year through the XHB and the ITB that outperform the S&P. They're breaking out against the S&P. Polte and DH Horton, two of the ones we individual shares we featured for literally the last couple of months, have skyrocketed in the last couple of months to record highs. Recently, we got involved in the Wood ETF, a stock like Trex TREX as breaking out right now, one of the ones we just highlighted last week in our portfolio playbook, you know, and how that all plays out. The other hot sector is back to InfoTech and the XLK, and we hold both of these in our discretionary portfolio. We have all kinds of portfolios within the portfolio playbook specifically for different types of investors. You know, for the discretionary portfolio, where I basically, you know, decide what it is based on my experience, based on the quant, based on the technicals, based on the fundamentals, based on the monetary, based on the psychological, based on everything. Xlk is among them. The InfoTech S&P ETF right within that sector semiconductors, the SMH, we've been all over it. The stocks that we have recently featured and go all the way back, really even to, you know, say, late August, early October, and that was a carryover from earlier in the year when we were bullish on all these stocks was Monolith Power, mpwr. It's up 69% in the last 52 weeks. Advanced micro devices up 109. Broadcom up 102. All right in that context. But in this vein you say, well, you know how is all this with banking going to be, you know, positive for other things, especially even in housing? Because let's look at the history, let's look at the pattern. In March, when AVB went belly up, when you know we're talking about First Republic having difficulties, what happened? The Fed printed the most money ever in a single week, ever outside of three weeks, at the peak of the pandemic in 2020, way more than any week in 2008 and 2009,. Because of two banks. Well, how much money did it get to print to protect a bunch of small banks? I mean, let's not even talk about losses on bonds that these banks hold. All right, the bottom line is, even this commercial real estate kind of implodes. You say, oh, that's bearish for this and for the whole reflation. They're kind of print. Imagine how much money they're going to print then. All right, we see what the dollar's doing. The dollar's breaking down right here. I mean, it's $1,070 below $99,26. There's 9% to 10% of downside in the dollar. That certainly helps stocks, it certainly helps the kind of reflation play and when they print their money it's going to be dollar bearish. It's back to the XLRRE the real estate sector, housing, the supply demand imbalance, the builders, all of that, all right. And within that context, the XLRRE, we break down every sector index from the S&P, the S&P 500 and all the S&P sector index. The XLRRE is one of them and within that we called the top four right now in terms of performance over the last 52 weeks and not based on performance that we call them, but now they just happen to be the top four Well tower, up 35%. Iron mountain, up 25%. Simon property group, which we really caught the bottom 22%, and digital reality, 26.8%. But the dollar decline, should it take out 99,26 and I think it will that's bullish for a lot of things like gold, bitcoin, base metals, uranium, a variety of commodities, all the building materials wood, lumber were already involved in that. The WOD is the global timber. All right, lumber got to break out. If it gets above 590, it's going to take off. These are, you know, trades that when the Fed reacts to anything in the bank system by printing more money, will be seen as acquiescing to higher inflation, which is what I've been saying for all of these episodes since we started this podcast over a year ago. And here we are, right when we thought we'd be and pretty much within the timeframe we laid out a year ago In that context, you know, with gold getting hot and we see that finally, maybe that you know the finally the gold is going to break out and finally you have the participation of like platinum, which hasn't performed at all. Thousand dollar discount to gold. The PPLT is the platinum ETF. There's a free before you right now. We just bought platinum this week. The gold guru is a redo of an old newsletter I used to do used to be Prudential Securities official research when it was called the metal monitor. We're offering that now too. Just, you know, in terms of the weekly report on the portfolio playbook coming Wednesday the gold guru done weekly. The big full of blown report, also on Wednesday, if you want an instant. The precious matters, particularly the mining shares which we break down, all of them from the juniors to the majors. Portfolios, again specific for different types of investors, including my discretionary portfolio picks. Sales at Weldon onlinecom. Sales at Weldon onlinecom. Get my bank report that I just did today. Get the gold guru that is Wednesday coming out the weekly report, and get the portfolio playbook, the big weekly that will help you in the stock market to really you know identify some of these themes from the macro thematic standpoint and from the quantitative standpoint, from the technical standpoint, and when all of that blends together, that's when we pounce. Thanks for listening. We'll catch you on the next episode of Money Markets and New Age Investing and don't forget to follow us on Twitter. You can find me at Weldon live and you can find the podcast at money underscore podcast.