The Fed Will Shock The Market And Cause A Sharp Dip in 2023
Hawkish Fed Will Stay Tight Longer Than Market Expects
Everything is all about inflation. The Fed is in the middle of a tightening cycle because of high inflation. The stock market is rallying due to ideas that the Fed will stop tightening at about 5-5.25% in 2Q2023.
Instead, the Fed will:
• Keep raising interest rates to over 6%
• Keep interest rates higher longer than the market will expect
• Cause a deeper and longer recession than expected.
The Fed looks at CPI and other forms of inflation and see it going down. CPI was over 9% just a few months ago and is now in the low 6% area. The market sees the same thing.
So the Fed is now about to slow their roll and start doing just a few more .25% hikes. This has led to the market thinking that the terminal rate, the highest Fed Funds will go to, will be about 5-5.25% and peak in, say, May.
By then, inflation should be down to perhaps 4% having been cut in half from the peak.
The Fed will throw a party celebrating their incredible wisdom and ability to manage the economy. Shoot, they may be able to ease before there is a recession.
Fed head Jay Powell will be feted as the best Fed Chairman in history.
Hey, not so fast.
The chart in this article shows shows sticky inflation. That is things that lag the inflationary cycle because they are not volatile like food and energy. Instead, they are things like rents and wages. It's hard to get reduction in rent and wages once they have been hiked.
It shows sticky inflation at nearly 7% and clearly trending higher, the exact opposite of headline inflation.
We could easily see stickly inflation go over 7% and stay there for over a year.
But the situation might be worse than that.
Volatile commodity prices are currently trending higher after being stomped on in the second half of last year. Even crude oil is starting to increase in price along with copper.
How could these critical commodities be climbing higher in the face of a recession?
The market is looking at China and betting that the end of Zero Covid marks a resurgence of the world's second largest economy.
They are the biggest importer of:
• Iron ore
Also, the grain market was recently shocked at how little grain was planted this year. So that will increase food prices later this year.
The net result is that volatile inflation has basically stopped going down or at lease stabilized near current levels just as stick inflation is still rising. In fact, CPI would probably not be dropping if it were not for auto prices! Just one factor is driving CPI lower!
But markets are buying the Fed's snake oil and rallying on expectations of easing Fed interest rates in 2Q2023. Stocks, bonds, and gold are all rallying on this premise.
But they will be shocked when inflation doesn't keep declining and the Fed keeps raising rates. They will have to shift their thesis on the market and drop all those three assets lower to discount the lack of rate cutting.
That will set up a 5-10% decline in stocks and gold and a drop in bonds.
So how do we make money?
Right now, I am still long gold and stocks but have no position in bonds. I'm going to keep those positions because I think the timing of the coming dip might not be until at least March so I can continue to make money on the long side.
But I will keep my finger on the trigger to shoot those long positions very quickly. I'll take a look at the situation then to determine if I want to go short.
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