Will He or Won't He?
Powell speaks today. Will he wear his traditional dovish cap to buy more time for inflation to naturally fall or will he go for the "win" to stop the inflation bleed? Odds favor the Dove
Powell speaks today. As I have been discussing, he likes to be a volatility dampener rather than a volatility accelerant. Given that cross-asset volatility remains elevated and the trading environment has been challenging for most investors, I think the base case is that he seeks to dampen down volatility again this afternoon when he speaks. He has already conditioned the market to the belief that 50bps rate hikes are coming for both the June and July meetings. We also know that QT starts next month which will add more to the tightening. Even after the hot CPI print last week, the Fed still sees inflation falling through the second half of the year so it will be challenging for them to tell the market that they are willing to tighten more aggressively in the very near term.
Ironically, as I have continuously discussed, giving the market this kind of near-term assurance on the rate path could perversely act to loosen financial conditions and give way to higher inflationary expectations again (likely through high energy and food prices if the $ weakens). So any positive reaction to his "dovishness" may ultimately be short-lived if it pushes us further away from achieving the goal of stomping out inflation. We think a break-out higher in oil prices is likely and will act as a real restraint on future growth and ultimately lead to risk-off behavior in the coming weeks that keeps the Fed more in a tightening agenda rather than quickly shifting from an inflation-fighting bias to a growth-supporting one.
The only real potential for a hawkish surprise today would be that he admits he misspoke during the Fed press conference regarding the possibility of a 75bps hike for the July meeting and that in fact, that could still be on the table. If we heard that from him, we would get more negative on risk assets more quickly.
We wrote last week that we were positioned very risk-off and were watching for a capitulation bottom. That never came even after the hotter than expected inflation readings of last week. Front-end interest rates came in and markets were able to find a short-term bottom at around the 50% retracement level for NQ from the Covid lows to the recent highs. We advised our subscribers and Twitter followers in real-time that we stopped out of the additional risk-off positioning last Friday morning.
We are still positioned similarly but with much sized down exposures. We are waiting for oversold conditions in risk assets to alleviate themselves before re-engaging with full exposures again. While there is a chance for Powell to kick off a bout of renewed selling again today, the odds favor the other way so we will wait patiently until higher levels are reached and we can re-engage with shorts. Our Macro Heat Map of Overbought/Oversold Conditions is below. With Vix, credit spreads and the $ still more overbought than not, financial conditions remain tight and we just don’t think Powell has it in him to put the nail in the risk coffin today, particularly given his historical biases post his perceived tightening mistake in December 2018.
Long gold and gold miners via GDX
Long crude calls
Short IWM/QQQ/EEM/EZU/EWZ/EWW via puts and futures
Long DBA (agriculture commodity ETF)
Long KEUA (European carbon credit exposure)
Single Name Exposures
Long MP/LNG/NOG/CCJ/MOS (various long commodity-related names/inflation hedges). Added VLO and XOP, replaced out FCX and AGRO
Long FRO/STNG (tankers that will benefit as storage plays in the oil storage world)
*Important Disclaimer: This blog is for educational purposes only. I am not a financial advisor and nothing I post is investment advice. The securities I discuss are considered highly risky so do your own due diligence.