February Blues pt. 2?
Something looks a bit different...
Around this time last year, I was watching as JPow chose to completely ignore FCI easing and failed to refute the erroneous expectations of 2% inflation by June ‘23 with rate cuts following shortly after.
February kicked off with a bang at the FOMC meeting. Powell’s willful negligence of FCI easing since Oct & failure to swiftly refute the erroneous claim that inflation would be sitting at 2% by June with rate cuts following shortly after leaves the Fed even further behind the curve. The Fed made another major policy mistake and put their tenuous grasp of inflation on display. The following day, we recorded the highest call option volume ever. Talk about FOMO. —
Looking at current conditions pertaining to rate expectations and inflation, it’s almost laughable how similar they are. We just witnessed JPow fail to push back against a historic FCI easing. Yes, he was definitely hawkish at the last FOMC meeting, but there was still a mention of cutting rates 3 times this year — which is expected to begin as early as May.
This isn’t necessary (imo) given that:
JPow mentioned how movement in yields can be considered as implicit tightening/easing. And once again, we had the fastest FCI easing ever within 2 months. The pivot crew has finally gotten the rate cuts they’ve longed for since March ‘22 :)
Economic data keeps surprising to the upside.
Thus, their tenuous grasp of inflation is still on display. A little blast from the past:
Their biggest concern is still routing inflationary psychology, which JPow first alluded to in the fall of ‘22 at the Jackson Hole Economic Symposium. If you ask me, inflation is already entrenched. Consumers are tired of dealing with it — rightfully so — and they won’t be given real breathing room until inflation is anchored at 2%. There are too many risks to the upside for inflation for the Fed to consider cutting until they see that inflation is anchored at 2%.
On the other hand, I can see a need for the Fed to cut rates — to uninvert the yield curve. It’s been deeply inverted for quite some time now. This is also important. At this time last year, bonds were erroneously pricing in a recession (deflation) amidst an inflationary bear market. Now, they are pretty much in limbo.
After the 2s10s & the 3m10y spreads steepened materially late last year — a signal that stagflation was coming and is now here in its nascent stages — the curve has been stuck in no man’s land. The Fed (and the Treasury) have a big decision to make; let the long end do the work for them through a bear steepening, or let the short end do the work through a bull steepening. Irrespective of whichever they choose whether willingly or by force, the steepening of the yield curve is something to watch.
While pundits proclaim victory through soft landings, the yield curve still says that we have a ways to go before being confident on that front.
Here’s where things get interesting. I’ve had an eye on oil since early ‘23. Besides the uptick in July-Sept which I called and positioned for; oil has remained fairly stagnant. This time last year, the SPR was still being drained a great deal, positioning was not nearly as skewed to the downside, and China was just reopening.
Now, the SPR is no longer being drained, positioning is nearly max short oil, and China is in position to finally implement a stimulus potent enough to bring their market back to life.
What’s even more interesting is what’s happened in the past few weeks in oil. For starters, as oil continued its ascent, on the week of Jan 29th, a headline released that sent prices spiraling down. This came immediately after a small pullback in oil, which I expected, but the pullback was unequivocally exacerbated by the headline which stated that Israel had agreed to a ceasefire proposal.
This was clearly nonsensical given the current state of affairs, and this headline risk is something that I’ve mentioned previously to be cognizant of.
OPEC+ remains the captain of the oil market. Thus, all eyes should be on OPEC+. With regards to the oil market; there will be many more headlines in the future that are released with the intention of misleading you — so proceed with patience, discernment, and wisdom. —
Nonetheless, oil has gradually recovered most of the losses from this. It is still outperforming the S&P, albeit slightly, and the Dow by a larger margin. The Nasdaq has recently surpassed oil and I’m curious to see how long this will last.
With CPI just ahead of us this week, there is reason to believe that this upside move can continue, especially if CPI comes in soft. Given the volatility of inflation & base effects, I believe that there’s a good chance YoY CPI comes in at high 2s at some point in the 1H of this year. This would invalidate my initial claim that CPI has troughed, but not by very much.
Admittedly, it takes time for the effects of historic FCI easing & inflationary geopolitical tensions to begin to show in CPI readings. Had oil never fallen substantially from its peak in late September, we’d be looking at a different picture entirely.
When base effects start to kick in later on in the year (summer at the latest) we should begin to see an uptick in CPI. This, of course, assumes that inflationary forces will work their magic — courtesy of the fastest easing of FCI in history induced by Yellen & co, and aided by JPow.
That being said, my positioning is as follows:
Long June 14 ‘24 CL 69 Calls
Long June 28 ‘24 4800 SPX Puts
Long Feb 21 ‘24 5100 SPX Calls
Until next time,
Pierre