Trading: Should We Be Fed Up With the Fed?

In today’s article, “Trading: Should We Be Fed Up With the Fed?” we discuss exactly that with the latest scoop of trading news!

Inflation, Recession, and Money
“Stagflation” is a word we’ve been hearing a lot lately. But what does it mean?

The word first arose in the 1970s, as an unprecedented combination of slow economic growth plus inflation created misery for millions of Americans.

Today we’re seeing similar conditions… the artificial stimulus of the post-pandemic period — actually a continuation of policies already in place, justified by COVID measures — has worn off, and we are left with an economic hangover.

Worse, all the trillions of dollars released into the banking system and financial markets finally made its way into the real economy, just as the availability of goods hit all-time lows. More money chasing fewer goods means inflation, as prices rise, spurred by expanding demand.

There has been a lot of supply-side inflation, as well, with producers paying more for the commodities they need to meet production goals, and passing those costs on to consumers.

Stagflation truly is the worst of both worlds — economic recession, with the resulting job losses and constricted opportunity, together with rising prices that further erode our standard of living.

For obvious reasons, people don’t like stagflation… or the politicians they blame it on.

That’s why President Biden and his team are so insistent about doing something to “bring down inflation.” The problem is anything they do is likely to tip the economy further into recession.

It’s a very thin line – a razor’s edge, really – that the “in” party is trying to walk. And the “outs” are only too happy to help them fail… after all, there are Congressional seats up for grabs. (Never mind what’s actually best for the country.)

The result is that We the People end up as a political football.

Instead of openly debating which policies would best address the systemic imbalances driving out current economic dysfunction, our politicians are busy posturing in front of cameras and producing sound bites.

For this reason alone we think it’s very unlikely that there will be any resolution to the current stagflationary crisis before the November election… unless the markets make it happen despite our “leaders.”

Investors more than ever need to protect their portfolios in the event of a major shock. And as traders, all we can do is prepare to take advantage of more chaos.

FFR Trading’s Strategy Team will give you several ideas on how to position your trading account for gains, whichever way interest rates and the economy are going. Call (800) 883-0524 to speak with a Trading Strategy Team member, or click here to schedule a strategy call.

The High Cost of Rising Rates
Last week we described how interest rates are the “price of money.” What does a higher cost of funds mean for businesses in today’s stagflationary environment?

To get a better understanding of this question, let’s look at the housing market.

According to the National Association of Home Builders, housing accounts for 15-18% of Gross Domestic Product. 3-5% of that is for residential investment, and 13-15% is consumption spending on housing costs, which includes rent.

With the 30-year mortgage rate recently soaring to over 6% — more than double where it was in January 2021 – rates are now higher than they’ve been since the 2008 crisis. Unsurprisingly, this is having an effect in the housing market. Here’s a recent article from CNN Business:

5 signs the housing market is starting to slow down

 There is a shift happening in the housing market. After more than a year of soaring demand, exploding home prices and increasing real estate sales, the market finally seems to be cooling off.

“The housing market isn’t crashing, but it is experiencing a hangover as it comes down from an unsustainable high,” said Taylor Marr, Redfin deputy chief economist.

Mortgage rates have increased more than two and a half percentage points this year. And the higher costs of financing a home have changed the calculations for many would-be homebuyers. As a result, year-over-year home sales have been dropping in recent months.

As rates go up, housing affordability goes down… dramatically. Since prices are still sky-high, reflecting the affordability made possible by easy money, the cost of buying a home now is prohibitive for many families.

In fact, housing affordability has reached its lowest point in 30 years. Under this pressure, it seems home pries must fall. This recessionary pressure is bound to have an impact elsewhere in the economy.

With this increase in rates, new homebuyers face an average monthly payment $2,128 on a typical new $350,000 mortgage — up from $1,523 just six months ago. That’s a 40% increase!

Bottom line: A slower housing market translates into lower GDP, and these effects are bound to ripple through the economy, as everyone from real estate brokerages to Home Depot experience declining sales and profits. And this is only one (small, but significant) example of how rising interest rates impact the entire economy.

Then there’s corporate debt.

Last week we talked about how many companies – even AAA-rated borrowers – often carry a portion of their debt at a floating rate.

When rates go up, as they are now, the cost of servicing that debt rises. This means these companies must pay more out of their revenue to service debt… which impairs earnings and reduces profits.

But that’s not the worst of it.

Many lower-rated corporate borrowers are faced with the unappetizing prospect of debt service rising above their ability to pay. According to a recent tweet from bond expert Stephanie Pomboy, investors should “Prepare to see an absolute ONSLAUGHT of corp[orate] defaults and downgrades. The myth of corp[orate] B/S [balance sheet] strength is about to be shattered spectacularly.”

In a nutshell, the Fed’s artificial stimulation of economic activity through unsustainable ultra-low interest rates is coming to a thundering end. And the end could be far more shocking than Fed Chairman Powel and Treasury secretary Yellen, or their sock puppets in the media and on Wall Street, could ever imagine.

Don’t be fooled by the apparent calm… the storm is coming! Now is the time to prepare your investment and trading portfolios. At FFR Trading, we specialize in helping clients profit from turbulent financial times. Call (800) 883-0524 to schedule a strategy call.

Driving By the Rear-View Mirror
Imagine trying to steer your car based on what you see when you look in the rear-view mirror. Well, that’s how the Fed sets monetary policy… and it’s working about as well as you’d expect.

What we’re seeing currently is that the Fed is pursuing a tightening monetary policy. Their controlled demolition of the stock market is proceeding more or less as planned. As we suggested in January and again in May, a slow disinflation of the crazy stock market bubble has been the Fed’s goal since the start of the year.

And as if that wasn’t hard enough, they have to accomplish this without causing a panic in the bond markets.

Realizing too late that they had overheated the markets with a bottomless punch bowl of free money, Powell et al set the intention of bringing down inflation by slowing the economy, which they mistakenly equate to the stock market.

Now, as they look backwards and realize that the object in the mirror (inflation) is closer than it appears, they are continuing to tighten.

The policy they’re following is not the one they announced… so far, there has been virtually no reduction of the Fed’s balance sheet. This is because selling bonds into the market will push rates even higher.

Instead, they are pulling liquidity out of the banking system by increasing reverse repurchase agreements. This process is explained in detail in an article from the Mises Institute. A short excerpt is included here, but the full article is highly recommended:

In a reverse repo transaction, the Fed temporarily sells a bond to a bank (just as they temporarily buy a bond from a bank in a repo transaction). This sucks reserves from the system, just as repos add reserves to the system. From virtually zero in March 2021, the amount of reverse repos has increased to $2,421.6 billion as of June 15, reducing the amount of available reserves by the same amount. The Fed balance sheet has not shrunk due to simple accounting: the bond underlying the repo transaction is still recorded on the Fed balance sheet. Banks, meanwhile, benefit from this transaction even though their reserves are temporarily reduced, earning a practically risk-free 0.8 percent (the Fed increased the award rate on reverse repos to 1.55 percent on June 15 and will likely increase it in the near future as the market rate keeps rising).

What is certain is that the Fed is now neutralizing its previous inflation… After peaking at over 23 percent, the reserve ratio has steadily declined since September 2021, hitting 19 percent in April… Since reverse repo transactions have continued in May and June, the monetary contraction seen in the first quarter is likely ongoing, although we will have to wait for more recent money supply figures to confirm this.

Some big traders are beginning to notice this reversal in market momentum. According to Zero Hedge, over the weekend Goldman Sachs noted that “at last week’s FOMC presser Powell specially said the hot CPI and the increased Michigan expectations were the reasons why the Fed went 75bp instead of 50bp. Well, it now turns out that that outlier inflation expectation print never actually happened, after it was revised lower which is why Goldman concludes that the ‘baseline for July will now move from 75bps to 50bps and the mkt clearly appreciated this.’”

What the Goldman analysts may be forgetting, however, is that the Fed tends to drive with its eye on the rear-view mirror. Can we really be that confident that Powell and crew will see the economy slowing in time – even though it’s their own policies that are applying the brakes?

For our part, we won’t be shocked to see the Fed continue to raise rates even after it becomes obvious that the economy is in a recession (which should be clear already.) If ever there was a gang that couldn’t shoot straight, the Federal Reserve is it.

Did you know that it’s actually easier to make money in trading when times are bad? As the Reddit crowd mourns their losses from this bear market, FFR clients are racking up triple-digit returns. Isn’t it time you got in on these gains? Call (800) 883-0524 to speak with a Strategy Team member today.

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