Larry’s note: Welcome to Trading with Larry Benedict, my free daily eletter, designed and written to help you make sense of today’s markets. I’m glad you can join us.
My name is Larry Benedict. I’ve been trading the markets for over 30 years. I got my start in 1984, working in the Chicago Board Options Exchange. From there, I moved on to manage my own $800 million hedge fund, where I had 20 profitable years in a row. And, I’m featured in the book Market Wizards, alongside investors like Paul Tudor Jones.
But these days, rather than just trading for billionaires, I spend a large part of my time helping regular investors make money from the markets. My goal with these essays is to give you insight on the most interesting areas of the market for traders right now. Let’s get right into it…
After denying inflation for the past year, yesterday the Fed decided to finally act…
They approved a rate rise of 0.25 percentage points. It’s the first hike they’ve approved since December 2018.
By waiting so long to act, the Fed has left itself with a near impossible task…
Correcting inflation is a delicate act, and when your only tool is the blunt lever of raising rates… Well, it’s just not something I’ve seen any central bank pull off so far.
Ultimately, when you keep raising rates to stamp out excess demand, you can’t tell that it’s working until you’ve gone too far.
To get it right would require that everyone react to each rate rise in exactly the same way and time frame.
For folks with less money, it only takes the slightest rate increase for them to close their wallets. But for others, it might take multiple rises over a longer time frame before things start to hurt.
It’s easy to hope for a sweet spot for both groups, and everyone in between… But it’s a trap.
Right now, the Fed’s final landing place has been tipped at a 2.8% rise. That’s where they’re hoping supply and demand will be in equilibrium and inflation will be in check.
But it’s wishful thinking.
There are a few reasons this simply can’t happen.
First, let’s consider the time lag…
Because the Fed is relying on historic data for each decision – like CPI and non-farm payrolls – it can take at least a month (or many months) before that data starts to flow through.
That means the Fed could keep raising rates well after the economy begins to slow. But that can create a downturn in the economy… leading to a drop in jobs and wages.
Don’t forget that it was only in December that the Fed predicted just three potential rate rises this year. Including this week’s rise, the Fed are now factoring in seven.
The Fed is just too far behind the inflation curve now.
You can see just how far things have got away from them in the table below…
United States Inflation Rate
Source: Trading Economics, U.S. Bureau of Labor Statistics
In March, April, and May, inflation accelerated quickly (almost doubling)…
Then, as it hovered between 5.3–5.4% from June through September, the Fed kept their head in the sand hoping it would all go away. Can we ever forget that word ‘transitory’?
The Fed didn’t realize the jig was up until inflation accelerated even further into the end of the year.
Although it raised rates by 0.25% at this meeting (with rises likely to happen at each subsequent meeting this year), there were still many members of the committee (7 of the 12) that believe this pace is too slow.
And I agree with them…
While I believe they should’ve raised rates by 0.5% this time – and have said so for some time – I think a 0.5% rise is right around the corner. It could happen as soon as next month.
Last week, I wrote that no matter the decision the Fed made at their meeting (0.25% versus 0.5%), it would still take some of the ongoing speculation out of the market. That would give the market some much needed certainty.
That’s exactly what happened. After the Fed’s decision, we saw the S&P 500 close up over 2% on the day, with the Nasdaq up 3.7%.
However, we need to remind ourselves that there’s still a long way to go.
While the market reacted positively to the Fed’s decision, there are still a lot of rate rises to come… And there’s no guarantee that the Fed will get on top of inflation, even if it raises rates all the way into next year as well.
So that’s why I remain extremely cautious about the markets. In fact, I still expect the year to finish with all major indices in the red.
I know from experience that once inflation takes hold, it takes a lot of prolonged pain – more than the market and most folks ever expect – to reel it back under control.
Editor, Trading With Larry Benedict
How do you think the Fed should handle inflation?
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