Waiting for the next Fed hike

The most important thing in markets right now is the next fed hike. Here’s what the latest expectations are:

  • July 26-27: 75 bps hike
  • Sept 20-21: 50 bps hike
  • Nov 1-2: possible 25 bps hike
  • Dec 13-14: possible 25 bps hike

The rate that the fed most directly controls, which has the biggest effect on markets, is the reverse repo rate. This is the overnight rate that large institutions can get by parking money at the federal reserve. The current amount of money sitting there is near all-time highs around $2.15 Trillion.

Here’s what those Reverse Repo Rates look like recently:

  • 3/16/2020: 0% set after pandemic start
  • 6/17/2021: 0.05% set to prevent t-bills from going negative
  • 3/17/2022: 0.30%
  • 5/5/2022: 0.8%
  • 6/16/2022: 1.55%
  • *7/27/2022: 2.3%
  • *9/21/2022: 2.8%
  • *11/2/2022: 3.05%
  • *12/14/2022: 3.3%

As you can see, it’s quite a fast hiking cycle. The rate levels may not seem like much compared to rates before the global financial crisis, but we have a lot more debt since then – government debt and more importantly corporate debt, much of which has been crowding between the last peg of “investment grade” and the first peg of “junk”, a level which has enormous implications for how much of this debt large institutions and banks are allowed to hold.

Here are some examples of how fast this hiking cycle has been:

  • Mortgage rates (30 year fixed) have gone from a low of 2.77% to a high of 5.81% in the past year. That means anyone using a mortgage to buy a home must pay more than double in mortgage payments. Investors also have to pay more when they borrow against their portfolios, and they tend to back off when they expect a downturn in housing anyway. In addition to a housing slowdown, homebuilders who pre-sold incomplete homes a year ago may see these sales fall through when the buyers can no longer qualify for the loans once their projected payments are doubled.
  • Bond portfolios and US stocks have lost a significant amount of value, as you can see in the chart below. I still wonder how many large “shadow banks” are struggling with these losses and may be forced to liquidate their portfolios. There’s no way of knowing until it happens, just like nobody heard of Archegos Capital until it blew up last year. Basically, these entities borrow on short-term markets, often overnight duration, so they can be forced to sell their holdings to reduce this debt when their portfolio values fall. When these entities are stressed and need to sell, they tend to sell their most liquid holdings first like US Treasuries and government guaranteed mortgage-backed securites. If they are forced to sell their junk bonds, those prices can really plummet.
  • The US Dollar has been strengthening worldwide. Moves YTD:
    • -2.2% CAD: Canadian Dollar to USD
    • -4.3% Gold to USD
    • -4.7% AUD: Australian Dollar to USD
    • -4.7% RMB: Chinese Yuan to USD
    • -6.9% SIR: Indian Rupee to USD
    • -10.1% EUR: Euro to USD
    • -11.4% GBP: British Pound to USD
    • -18.0% JPY: Japanese Yen to USD

A strengthening US Dollar is a wrecking ball to worldwide growth, as offshore US Dollar denominated debt is enormous.

What will end the fed hiking cycle?

  1. A major disruption in the financial system, as large shadow banks are forced to liquidate their holdings quickly and prices plummet. This is what I expect to happen at some point, it will be similar to Bear Sterns and then Lehman Brothers collapsing in 2008. My best guess is that it happens this fall when liquidity conditions are seasonally tighter (Sept/Oct).
  2. A large drop in the CPI (year over year percentage change). This may seem impossible given the recent hype around the high year-on-year numbers, but many commodities have come down substantially from their peaks this year including oil, copper, lumber, agricultural products, steel, and many others. Inventories have been building at retailers as well.
    1. The consumer price index has been rising over 5% for a full year now, so prices only need to stop moving for a few months to bring that annual rate down quickly.
    2. This is a lagging economic indicator, so it can take a few more months to slow the fed, but a number of leading indicators, like new orders and consumer sentiment, have been dropping.
  3. A spike in layoffs. This is also a lagging indicator, so it can take a few months to slow the fed.
  4. A plunge in job openings. The federal reserve has talked a lot about the high number of job openings per unemployed worker, so a large drop here would get them to slow or pause (but not reverse) their hiking schedule.
    1. Note that a number of indicators don’t look good for the labor market. Real wages have been substantially negative for over a year, the labor force participation rate has been dropping, and average working hours have been dropping. These are important indicators of the health, or lack thereof, of the labor market. Don’t expect these to move the federal reserve though, they are under enormous pressure to get that CPI down before the midterm elections in fall, and that’s what they plan to do.

I didn’t make any trades this week. I’ve basically been focusing on moving as much money as I can into my stock account and resisting the urge to buy any dips – which was especially hard with those dips in Uranium miners last Thursday – but I need to get my margin level down so that my cash levels are closer to zero. I will buy some more Jan 2024 TLT calls after the fed hikes rates late July, but until then I’m going to be very careful about buying anything.

Here’s where my portfolio allocations ended up. Basically another -3.8% overall as my gold and silver mining stocks got slammed particularly hard, along with my TLT calls.

  • HEDGES (13.9%)
    • 13.9% TLT Calls
  • PRECIOUS METALS (34.0%)
    • 4.2% AG
    • 4.1% MTA
    • 3.8% SILV
    • 3.0% LGDTF
    • 2.6% EQX
    • 2.4% SLVRF
    • 2.6% SAND
    • 2.0% MGMLF
    • 1.9% SSVFF
    • 1.7% RSNVF
    • 1.6% BKRRF
    • 1.5% HAMRF
    • 1.7% MMNGF
    • 1.2% DSVSF
  • URANIUM (25.7%)
    • 4.9% CCJ
    • 3.6% DNN shares & calls
    • 3.5% UEC
    • 3.2% UUUU
    • 3.3% BQSSF
    • 2.9% UROY
    • 2.0% ENCUF
    • 2.3% LTBR
  • US CANNABIS (14.7%)
    • 1.9% AYRWF
    • 1.7% CCHWF
    • 1.6% CRLBF
    • 2.3% CURLF
    • 1.7% GTBIF
    • 2.2% TCNNF
    • 1.2% TRSSF
    • 2.3% VRNOF
  • BATTERY METALS (11.5%)
    • 5.1% NOVRF
    • 4.6% SBSW
    • 1.8% PGEZF
  • CRYPTO (2.5%)
    • 2.5% XRP
  • OTHER (3.6%)
    • 2.8% DOCN (w/ covered calls)
    • 0.7% OGZPY
    • 0.1% TWTR call
    • 0.0% ATCO calls
  • CASH (-5.9%)

About johnonstocks

I've been trading stocks since 2003, active on Motley Fool's discussion boards and using first Hidden Gems, then Global Gains. I no longer have the newsletters, but I keep up on the WSJ and read David Rosenberg everyday at gluskinsheff.com. Education: CFA level 2 candidate MBA-focus in Finance, Marshall, University of Southern California - expected Dec 2010. BS Mechanical Engineering, UC San Diego, June 2002
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