Final FOMC Rate Hike
Weekly Plan 9.17.23
Hey folks-
From the previous weekly plan, my main context was range bound action in the SPX index with resistance near 4550 and support near 4450. AAPL was a drag on the index, whereas some mega cap stocks like TSLA and AMZN helped it stay afloat.
Looking ahead this week, the flows can be dominated by US dollar and longer term treasury yields which themselves will be impacted by language coming out of the FOMC meeting on Wednesday.
Below are my 2 main scenarios for the Wednesday FOMC meeting-
The FED delivers a 25 BPS rate hike, accompanied by strong language such as the “risks to upside inflation have now increased in last few weeks”. This I think will be decidedly a very hawkish statement and will be good for the US dollar in the short term and could add pressure on the risk assets like QQQ and SPY.
The FED does not raise any rates, but keeps the door open to another 25 BPS rate hikes towards end of the year.
Both of these are some what hawkish scenarios, however, I do think Scenario # 2 is priced in to a large extent whereas Scenario 1 will be the surprise scenario. Right now the majority expectation is for the Fed Funds Rate to remain unchanged at 5.5%. Remember, this time last year, the expectations as that inflation will be vanquished and the rates will be around 3% towards end of the year. This was a main factor in the bear market rally that ensued. Yet here we are closer to 6% at end of 2023, worlds away from that 3%.
When I look at the Dollar $DXY and yields, I think they are indicating possibility of Scenario 1 playing out but then I am also cognizant that how risk averse Powell is when it comes to rocking the QQQ boat too much, so, I personally think this FED will opt for Scenario 2 on Wednesday as they have now been more active on the balance sheet reduction side than finagling with longer dated treasury bonds.
This can be seen in amount of cash flowing back to their overnight reverse repo operations as well as the overall bank reserves which are now dwindling.
If it is indeed Scenario 2, there may be a knee jerk reaction to see a rally in risk on names. In particular, I am interested in Oil price action. Oil (WTI) did NOT offer meaningful fight at 88 level which I thought it will and instead rallied to close near 91 right now. I think if it is Scenario 2 we can see Oil (WTI) rally to 94 and if 94 gives up, I personally do not see a resistance until 108-110 a barrel.
Take a look at the 1 year chart of FED balance sheet below. Chart A.
I predicted this will make a new low back in March, despite that little blip higher due to the regional banking mess and has since been moving in the direction that this FED wanted. I think this trend may continue until something major breaks (again).
So, I do expect the FED to continue to do more stealth tightening via their balance sheet reduction and leave the rates to just rhetoric rather than actual action of increasing them. Average person in the US does not feel balance sheet reduction outright, but they feel the pain of rate increases almost immediately. Average person also does not understand the full impact of QT on the markets. This is shrinking liquidity by billions every month.
This FED has no other choice either. There are things outside of the monetary policy ambit which are helping keep inflation buoyed.
The recent uptick in inflation as seen in recent weeks, can not be blamed on the FED alone. A lot of this has to be blamed on post pandemic dynamics as well as fiscal policies, plus the energy policies of this admin.
I have covered this in more details in prior weekly plans, but in short, the current admin has big push on moving away from fossil fuel energy sources as well as consumption. Merits of such a change are beyond the scope of this blog but this transition does not come cheap.
In fact, this is one of the most expensive changes for both the end consumer as well as producers and suppliers of such a transition. The Federal government provides fiscal stimulus to help make this transition but that also increases overall inflation in the energy sector. Energy sector is one of the biggest input into cost of many other sectors and it becomes a domino effect keeping inflation higher for longer in a wide array of sectors.
I am very confident that this trend will continue for next several years. If the Democrats win the presidency and the Congress in 2024 again, I expect the energy sector to make new highs and hence, I expect the inflation to remain perched above 3-4% for several years to come. On the core CPI side, this could be even higher.
Now, against such a backdrop, if the economy does not crash outright, and employment remains relatively stable around 3-4%, I think the FED really has no reason to pivot. The FED panics and pivots only if we see higher unemployment numbers next year, which I think is debatable.
So, in my opinion (IMO), this culminates in below lethargic combination-
Overall, I expect inflation to remain higher in the 3-4% + range thru 2025, may be even higher due to higher energy costs as a result of push into renewables.
I think this culminates into slower growth for most sectors of the economy with exception of a few bright spots.
I think the employment rate could remain stable for few more months to a year or so.
Against this backdrop, I would think the FED retains a hawkish tilt via stronger language but does most of the tightening via balance sheet reduction.
In terms of the US Dollar, it has been enjoying the tailwinds of a potentially hawkish FED on Wednesday versus an ECB which has already declared an end to any more rate hikes. Euro Zone is deeper in slowdown than the US right now is, but I think they will both catch up later in 2024 at some point.
A few months ago, I had called the TOP in $EURUSD near 1.13 level and it has since sold down into 1.06. That is a large move for EURUSD in a few months but now I think as we approach 1.04/1.05 area, this could become a support. I will be surprised if we begin to see sustained sell off in the EURUSD below 1.05. Note that in the Dollar index, Euro is the largest component and hence impacts the index the most.
I think this same dynamic could apply to the likes of Gold and Silver. On both of these, we are now trending near support levels and I think as long as these levels hold, we could now try and trade above 2000 on Gold, once the dust settles after this FOMC.
To summarize: Any sell off in the EURUSD (or a spike in the Dollar) due to a perceived hawkish FED on Wednesday could be short lived and I see support come in for EURUSD, Gold etc near these lows. The US will take a leadership role in this push to renewable energy and I think this will spell doom for the US dollar which I expect to collapse below 75-80 in next couple of years. I do think if we get a spike in the US dollar above 105-106, it may be short lived.
The main question this week is what will Powell say on Wednesday? Is it going to be more of the same: that we are data dependent. We are not hiking. We will keep rates higher for longer.
If this is indeed the message, I think the markets could rally on this message.
Really, I think regardless of what Powell says, we could see a spike-rally in the markets, UNLESS - he actually walks the talk and raises by at least a 25 BPS.
What does this all mean for the S&P500
There is no one size fit all answer to this question when it comes to answering it in terms of rate of inflation. There are bands of inflation which all have a different impact on something like Spooz.
Some inflation, coupled with moderate dollar strength is good for stocks. This will be 1-2% rate of inflation with Dollar not too extreme but in a moderate range. We saw this regime in last 10+ years.
Then there is extremely high rate of inflation, like we see in the likes of Venezuela, Zimbabwe where the currency halves in value or even more, within one year. This is something most of us in the West have never experienced first hand. Where we see this, everything that is priced in that currency also doubles in value in a year. If you provide services for a 100 dollars this year, but then the value of that dollar goes half next year, then automatically your services should cost 200 the next year. Now you can decide if that is a good thing or a bad. I would personally not want to be in this situation even though I can charge 400 the next year ;)
The 3rd scenario is where we are likely headed for a couple of years. This is longer term elevated inflation of 4-5% or more. I think this inflation will not come from products, rent or services but from energy. This is mostly of our own making by throttling down domestic energy production in the US and Canada.
Now historically, and we have data for this going back several decades, this is not a good combination for the stocks. At end of the day, a 5% inflation is an additional 5% tax on the money you make. It lowers your net income. You take home less, you spend less on products and services, the economy slows down. On top of that, when you see Gas prices also at 5-6 dollars a gallon, that is an extra pressure on the consumer. In the US, an average person can spend 7-10% of their income on energy. This includes electricity, gasoline and natural gas etc. With higher prices in energy, this number goes even higher. Before you know it, you are spending 15%+ of your income on just getting from point A to point B and an additional, invisible tax. This is bad for the risk on assets like high growth companies which see the value of their future income slashed.
This is one of the reasons, I think some of the lower targets that I have had in the US stocks near 3500 will at some point trade. Many furu have called for this to be birth of a brand new bull market but I think it is end stage, longer term distribution. These long term market cycles can be notorious to take a long time to turn.
Again, this is not a 0DTE or a weekly time frame call.
But since that target is still out there, let us zoom back into the weekly time frames for some names like AAPL, NVDA, TSLA and of course SPY.
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My levels for this week
So, with the SPX, on most of the days this week we saw the range between Orderflow levels shared by me in the chat and plan.
On the $SPX side (the cash index, not the Emini), longer term readers understand the importance of this 4500 level.
We rejected this again this week and were not able to close above it. This is a bearish signal but some price action context is needed.
We are right now in about an 8 week balancing session in the SPY. Balancing sessions, when they come in uptrends can signify continuation, however, I have my doubts here.
I think if and when we break 4350, this will technically show a lower low and a lower high on the SPX and I think in that case it will have resumed a new bear market to target 3500. We are about a 100 points from it at the moment. Please read all IF statements as they paint the full picture. A lot of guys read what they want to see and ignore the rest. This is especially important when we have not YET broken 4350. We have not even broken 4400 yet (At time of Friday close).
For next week my key levels will be 4450 (Emini) and 4517 (Emini). At time of this post we last traded 4500.
Scenario 1: I think any rallies into 4517 could be sold for a test of 4450.
Scenario 2: If we do trade 4450, I want to see what is AAPL doing, what is TSLA doing? Are they breaking key order flow levels or not? If they hold it, I think 4450 may be supported for a move back to 4517.
On Wednesday it can get quite volatile but my edge case will be 4450/4517. Above 4517 we could retest 4550s. Below 4450, I think 4400 comes in sight in form of more volatility.
Additional levels and scenarios may be provided for subscribers in the chat room below.
To summarize: I want to measure the risk on and risk off tone this week with names like TSLA and AAPL this upcoming week to make sense if some of levels like 4450 are gonna hold or fold. I do think the bears need to take out AAPL 172 to bring additional pressure. At time of this post, we are at 175 in AAPL and the week itself is an inside week.
Let us talk about some of the other related markets like TSLA now.
TSLA
Tesla does have some long term problems but in the short term, a UAW strike and 100 dollar Brent Crude ain’t one of them. These issues help names like TSLA, HMC, TM etc.
In line with what I said on Friday, I think if 260 is tested and holds, we could see 280 test on TSLA. We last traded around 275 on TSLA. I have been a TSLA bull recently from 220 and for me to become a bear again, I need to see some of the levels mentioned earlier last week give up on the downside.
Longer term, I am a TSLA bull. I know a lot has been said about how TSLA is a car maker and its multiples do not make any sense as a car maker but I do not agree that Tesla is a car maker.
I think it is far more than that and their margin situation will improve once they sell even more vehicles. They can sell add on services like FSD, connectivity, energy to name a few. This is a legit add on sale.
To counter this, what are legacy auto makers like BMW doing?
Well, BMW is selling a subscription to heated back seats.
This is how out of touch the legacy auto makers really are when it comes to competing with TSLA. I do not think there is any competition to TSLA now in the every day driver segment. When it comes to ultra luxury and ultra niche, that is a different conversation but what percentage of population is really biting into ultra luxury or ultra niche? Almost 0. My long term TSLA support comes in near 135 area and I think if it ever gets tested, it may be a good level. Long time readers remember I was extremely bullish on TSLA at 100 before it rallied to 300.
What else I am interested about?
GME
The “Dumb Money” movie chronicles how every day men & women beat Wall Street at its own game and got very rich in doing so. It shares the story of GameStop stock which exploded 100s of times higher in 2020 stimulus driven mania.
BTW longer term audience knows I was the very first one to share bullish GME call at 3 dollars before it mooned.