Fighting The Fed

Don't Fight The Fed

The economic news is far far too rosy for my cynical tastes. For those that don’t know, I was a floor trader for 30 years at CME. For the first sixteen years, I traded interest-rate futures. I specialized in spreads at the short end of the interest rate market, three-month eurodollar futures. Those don’t exist anymore because the LIBOR rate was gamed during 2008 by the big banks. Tell me why we bailed those people out again? Like sunlight, bankruptcy is a tremendous disinfectant.

The Eurodollars are now the Secured Overnight Financing Rate (SOFR) contract. You can see SOFR quotes here. This is where the mortgage market manifests itself, and other debt products. June (M) SOFR futures are trading at 94.865. That is meaningless to the layman. Doing some math gives you 100-94.865=5.135%. That oughta look a little more normal to you if you have talked to a banker recently.

In contrast, the Jun Fed Funds Futures are trading at 94.795. Doing the same calculation you get 100-94.795=5.205%, slightly lower than the SOFR. The difference between the two contacts is the amount of risk perceived. SOFR loans are riskier. The current Fed Funds rate is 5.33%. Hence, the market is telling you the Federal Reserve will cut rates by June.

If you look further out on the curve, the August Fed Funds futures are at 94.975, September at 95.05, and November at 95.25. That’s an expectation of two .25 percent cuts in the Fed Funds rate between now and the end of the year.

See the first line in this blogpost. Guess where it’s also priced in?

I hate to throw cold water on a great party, but I don’t think the Fed will move at all this year. Not one time. Steady as she goes. Why do I think this is the case?

The Fed has a dual mandate,

• hold the line on inflation

• ensure everyone has a job

Well, we all know how they have consistently missed on virtually everything as long as we all can remember. Men cannot predict the future, yet I am doing it here. I am a speculator after all. Without delving too deeply into it, the Fed missed badly on our last inflationary spiral. They also missed the banking crisis in 2007. They also kept rates at 0% for too long. Heck, they used to talk and hold seminars on deflation at the Federal Reserve. Remember those halcyon days?

Hence, they are gonna miss it again. They know if they cut by half a basis point, it will cause some irrational exuberance in the stock market but it will also cause prices to rise. I know every really intelligent smart person on television says inflationary pressures have eased but I am here to tell you while they are off their highs, they are still smouldering. Government is still spending money hand over fist like it is nothing and that’s not a cure for inflation. The Biden “Inflation Act” did nothing to quell inflation either. Inflation isn’t dead by a long shot.

I also think the unemployment rate isn’t going to go up appreciably in the next several months.

My friend tells me I am nuts and that the Fed is a political animal and will lower rates to make Biden look good at least one time ahead of November 2024. I am putting my faith in the Fed because Jerome Powell is a Grateful Dead fan. I think the bottle is dusty but the liquor is clean.

What should you do with this information?

Don’t wait for lower rates to buy a piece of real estate. Not happening. Besides, there is too much demand for housing right now. You aren’t going to refinance either.

Remember, the price of the contract moves inverse to the interest rate. Higher interest rates mean a lower contract price. Lower interest rates mean a higher price. Hence, 94.00=6% interest and 95.00=5% interest. Get it?

If you are a gambling man, buy some out of the money puts in the SOFR futures for September. You could also buy some puts in the S+P 500. It’s going to go lower if the Fed doesn’t ease, yet, it’s still going to be in positive territory on December 31st so don’t look for a Black Monday.

If you are really bold, you can sell the Sep 2024 SOFR futures and buy the Dec 2024 SOFR futures. If the Fed doesn’t move, Sep ought to fall off a cliff. An even better way to play it might be sell the Sep, double buy the December, and sell the March. Short the wings on the butterfly spread.

I am not trading at all but like Chance in “Being There”, I like to watch.