• Today, Chairman Pow backs himself into a corner.
• All signs point to “skip,” which means he’ll likely hike later.
• This isn’t a “pause” or a “pivot,” indicating a direction change.

Good morning from a rainy, soaked Asti!

It’s been raining here, refilling our reservoirs and rivers, which were dangerously low this time last year.

And the rain has kept it wonderfully cool at night. We’re nearly in summer, and I haven’t used my air conditioner at night yet. May that last a bit longer.

But turning to more important things like interest rates…

Jay Powell and the rest of the FOMC decide bigly today.

I know most think this move is a fait accompli. They’re standing pat, and that’s that.

But in this Rude, I’ll show you why doing nothing, in this case, is worse than doing something.

Market Refresh

I’ve updated our S&P 500 chart since we last looked at it in May.

We’ve made a clean break above 4,200 and then 4,300 (#11).

There’s no reason to be short this index at the moment.

By my reckoning, we can quickly hit the 4,600 to 4,650 range, where there is a bit of overhead supply.

But really, there’s not much stopping the index from hitting its all-time highs.

This chart is Exhibit A the Fed should not skip here.

Yesterday’s Inflation Numbers

But it seems we’ve got all about asset price inflation in favor of consumer price inflation.

Yesterday’s inflation numbers came in as expected. The CPI bumped up slightly. But the core numbers are still too high.

Credit: MarketWatch

To see the numbers in trend form:

Credit: The Wall Street Journal

From the Bureau of Labor Statistics:

The index for shelter was the largest contributor to the monthly all-items increase, followed by an increase in the index for used cars and trucks. The food index increased 0.2 percent in May after being unchanged in the previous 2 months. The index for food at home rose 0.1 percent over the month, while the index for food away from home rose 0.5 percent. The energy index, in contrast, declined 3.6 percent in May as the major energy component indexes fell.

For sure, the numbers are tailing off. And that’s good.

At the same time, is the Fed’s demand destruction working too well?

Commodities are way off, with oil and gas down hard.

That’s not because of the Fed or a strong dollar. The credit belts are tightening, and entrepreneurs see a recession from a mile away.

Here are the commodity groups’ performances since the hiking cycle began:

Livestock and the shiny stuff is up. Everything else has been hammered.

Sure, a stronger dollar would contribute to that. But I don’t think that’s the whole story.

So what are JPow’s options?

The Options

As I see it, Chairman Pow has three ways to proceed.

Hike

This one gets my vote. But he won’t do it this time.

My reasoning goes like this: if you’re going to continue to hike later, and the market is rallying this hard, and consumer product prices are still high, you may as well hike.

If you stop here, the market may interpret it as a permanent stance, provoking an even harder rally in the SPX.

Skip

From Nikileaks, in the WSJ:

Federal Reserve officials’ concerns about stubbornly high inflation could lead them to signal that they are prepared to lift interest rates again this year even if they hold them steady on Wednesday.

This is doing nothing under the guise of doing something.

By skipping, Powell means he won’t raise rates “this time” but fully expects to hike again soon. Perhaps as soon as next month.

This seems to be a way to keep the rest of the FOMC onside so there’s no full-blown mutiny when the announcement is made.

Again, from Nikileaks:

Signaling a rate “skip”—the combination of holding rates steady in June while signaling a high likelihood of a rate rise in July—could be tricky to explain to the public. “If you were absolutely sure you were going to go ahead with an increase at the following meeting, then you should just go now,” said William English, a former senior Fed economist who is a professor at Yale School of Management.

Agreed.

Pause

In this case, a pause means “lettings rates plateau here and then pivot to rate cuts.” Again, if the FOMC chooses to do nothing, it must stipulate that it’s ready to hike any moment.

If not, we’ll have out-of-control equity buying.

What Powell Will Do

I’m sure he’s going for choice B, the skip.

But he must execute this step delicately but firmly.

Powell must say something like, “We’re giving the market a month to catch its breath, then we’re coming back in full force. So be careful. You’ve got six weeks to sort yourselves out. Until then, I’ll be quiet. But we’re going to hike in July, so price it in.”

Then the belief he’ll hike again will be credible.

We’re not out of the woods with inflation, either on the consumer or asset sides.

He knows that. That’s why I find it puzzling that he’s skipping.

But then again, the politics in the Eccles Building must be palpable.

What If You’re Wrong, Seanie?

If I’m wrong and he hikes, this will be my reaction:

If he hikes, the market will be down at least 2-3%.

Why?

Because the last time I looked at the Fed Funds' futures, they priced in a 4.7% chance of a hike. So the entire market would be the wrong way around.

Credit: CME FedWatch Tool

Absolutely no one is looking for a hike. 

Could this be the perfect time to wrongfoot the market? Sure, if he wanted to do that. I don’t think that’s his game, though.

I think he’d rather keep the peace with the other members of the FOMC, who probably want a pause to figure out their next career moves.

Wrap Up

It’s a delicate balancing act. But in the end, the Fed will attempt to skip. Much depends on Powell’s presser, where he must convince the market a hike is on for the July meeting.

You couldn’t pay me enough to be the Fed Chairman.

I bet Jay Powell is wondering whether it’s all worth it.

Have a great day.