No Fed Fear Buoys Investors

The mandate of the Fed is price stability with maximum employment. In the intricate tapestry of economic policy, where every stitch is carefully woven into the fabric of the market, the Federal Reserve finds itself at a pivotal juncture. Employment has been maximized for over 2 years, goods inflation is stable, but the heavy hand of housing continues its inflationary journey of unstable prices. The confluence of factors, from housing to a stronger economy, have pushed the Consumer Price Index (CPI) higher than expected in the past two months. The projected number of Fed rate cuts has fallen from 6 times to just 2 or 3 cuts this year and yet most stock indices are a whisker away from another record high. Intrepid stock investors, mesmerized by the Generative Artificial Intelligence (AI) revolution, used the presumed bad news of higher inflation and fewer rate cuts to push the pause button in March. Despite some indices teasing record highs again this week, the stock market has been in a sideways congestion for a month. Unless shelter inflation falls more dramatically, the Fed will find it increasingly difficult to cut rates the longer they sit on their hands as the base effect of YoY monthly numbers will bottom out in a few months.

The Fed is acting more Dovish than the inflation data would suggest, telling investors “don’t worry, be happy” as they are willing to move the 2% CPI goalposts to a 2 to 3% range.  Fed head Jerome Powell is confident rate cuts will come this year, even in a strong full employment economy. This has been music to investor ears allowing their exuberance to appear – rational. Core PCE, the Fed’s primary inflation benchmark, fell YoY this week to 2.8%. The PCE data falling off the 12-month look allows for slightly lower inflation reports for three more months. However, from July through year end the base effect of YoY data dropping off will be hard to improve upon without a weaker economy. Given Powell’s messaging that he will cut the Funds rate this year, his best monetary easing window may be no later than the June 12th FOMC meeting.

In the hallowed halls of the Federal Reserve’s Eccles Building, where monetary policy is crafted with the precision of a master artisan, the debate rages on. The Fed’s reluctance to act, born of a fear of stoking inflationary flames, obscures the untapped well of existing homes waiting to be unleashed into the market. A paradox emerges, as the very act of cutting rates, so feared by the guardians of monetary stability, could pave the way for a deluge of homes onto the market from sellers previously unwilling to part with 2 to 4% mortgages. The domino effect of such a move, reverberating throughout the housing market and the broader economy, could reshape the landscape of homeownership for years to come.

In this delicate dance of policy and pragmatism, the Federal Reserve stands at a crossroads. The calculus of cutting rates, once deemed a perilous gambit, now emerges as a potential catalyst for change, unlocking a disinflationary trove of homes and reshaping the contours of the market. With mortgage rates still scratching  7%, a couple Fed rate cuts could allow a 5% handle on mortgages and unlock pent up supply.

The Fed’s steadfast grip on the Fed Funds rate, a bulwark against the specter of inflation, inadvertently serves as a barrier to the floodgates of the housing market. As mortgage rates soar and home prices reach dizzying heights, the Fed’s caution in lowering rates belies the potential for a seismic shift in the supply of homes. At 7%, the inventory of vacant homes will remain scarce, but the gravitational pull of a 5% mortgage would cause the inflationary housing tide to recede. Homebuilder stocks are through the roof and will keep building profits if the enormous exisitng home supply is frozen.

The monetary punch bowl remains with partygoers ravenous for chips and anything AI related. Yet, stock index Bulls have been stampeding up the mountain for 21 weeks on the Nasdaq (22 basis SP 500) without a notable retracement (>3%) of their journey. Being in overbought territory this long makes it exceedingly hard to advance much further without culling the herd of tired investors. Tempering the urge to hit the sell button is the legion of Bears and ardent Bulls begging for a pullback. The Citigroup Sentiment gauge reveals 6 straight weeks of investor euphoria that has merely slowed or paused the profit parade, while the overall Nvidia AI Bull market continues. Short term seasonality allows for modest gains into mid to late April, but this is not a time to convert the remaining 5.3% yielding money market cash reserves into growth stocks.

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