Elon Musk tweeted yesterday that the Fed needs to cut interest rates immediately in order to prevent a severe recession.
This, as the inversion of the yield curve continues to push the boundaries of what we know and enter further into extreme territory.
10-2 Yield Curve inversion at its most extreme point since 1983. Source: EarningsWhisper
Today, Fed Chair Jerome Powell may have given Elon Musk a little reason to smile — but he isn’t jumping onto the dovish boat just yet.
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What Jerome Powell said at the November 30th Brookings Institute Speech
The moment Powell took the floor at the Brookings Institute, the market started to react.
Coming to life after two days of running in place, the SPX moved from -0.1% on the day to +1.86% by 3PM.
The event saw one trader gearing up with 20,000 OTM SPX calls worth an approximate $36 million dollars expiring on December 30th. Just hours later, those calls have quickly soared in value.
But why did the market rally so hard? Powell gave the signal that the market has been waiting all year for: The Fed could begin slowing the pace of rate hikes as soon as December’s meeting. That could leans heavily on key upcoming economic data — like the jobs report, the November CPI, and the PPI.
However, for beaten down investors fearing a “Fed-made” recession, this is welcome news. And it’s a sign that a hail-mary is possible. If, on December 9th, new jobs come in below expectations (+200K), and the CPI (which comes just days later) begins to show signs of inflation abating, the market could get a welcomed surprise — a rate hike of less than 50 basis points, or as some analysts (including Jeremy Seigel) have suggested — a complete pause.
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That would be as close to an “all-clear” sign for the Santa Claus rally as is possible. As it stands, the market predicts a 25% chance of a 75 basis point rate hike (which Powell has all but suggested will not happen in December), and a 75% chance of a 50 basis point rate hike — leaving the door open for the market to be surprised if the Fed errs on the side of caution.
Still, interest-rate futures currently predict a Fed Policy Rate of just under 5% by this coming May — far higher than what it was predicting just a few months ago. There’s good reason for that. Despite his dovish comments, Powell said rates must remain “somewhat higher” through 2023, and that the Fed will need to hold policy at restrictive levels for “some time.” To put it simply, a pause here does not mean “no more rate hikes.”
Still, Powell finished off on a positive note. The Fed expects housing-services inflation to fall sometimes in 2023. The Fed also expects PCE inflation to begin decelerating in the upcoming data. Powell even gave a somewhat rosy outlook on the upcoming jobs report. This is all well and good, if these positive predictions come true. If not, the market could be setting itself up for yet another round of disappointing data.