The biggest news out last week was two FOMC members making their case for no hike in June. This language and timing is no accident. After 500 bps of 10 consecutive hikes, the effective Fed Funds rate is around 5.08%. We are at the cusp of a sea change, and the knock-on effects will be material, writes Tom Hayes, founder of Hedge Fund Tips.
Of note, Core PCE, the Fed’s favored inflation gauge is below 5%. Historically, this is when the Fed stops hiking (FFR above the rate of inflation).
This would give them time to collect more data and determine whether future hikes would be necessary or if they would be able to turn the skip into a pause. Last Wednesday evening, the “Fed Whisperer” at the Wall Street Journal – Nick Timiraos – confirmed the stance.
As we have stated since January, the key inflation months were going to be May, June, and July. This is when inflation would “fall off a cliff” due to base effects of owners equivalent rents (major weighting in CPI) and the twelve month lag on leases.
It would not surprise us to see a “3 handle” on the next print. We get the first of these numbers (May) on Tuesday, June 13. The Fed makes its rate decision on Wednesday, June 14.
We expect to see two meaningful changes in coming months as a result of the Fed being done:
1) The Dollar will resume its downtrend after a “debt ceiling safe haven bid” in recent weeks.
The most directly impacted asset classes from this development will be the groups that have been left behind in the recent rally. Emerging Markets and China will resume the uptrend they began in October. China trades inversely with the USD and is the heaviest weighting in Emerging Markets Indices.
Any multi-national company with revenues abroad will increase earnings materially as the USD weakens. Roughly 40% of S&P 500 revenues are generated outside of the US. For example, Intel (INTC) gets ~82% of their revenues from outside the US. 3M (MMM) gets ~49% of their revenues from outside the US. And PayPal (PYPL) gets ~47% of their revenues from outside the US.
2) Long Term Treasuries will begin to get bid after a few weeks of heavy issuance following the debt deal:
That will help interest rate sensitive sectors get bid. REITs have been left for dead, for instance. As the long end of the curve gets bid and rates come down, you will see this group begin to recover.
Banks will also start to get bid again as their portfolio and loan book “mark-to-market” improves – reducing the need to raise capital. Plus, small caps will get bid as banks begin to recover. They have been a major laggard this year.
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