The Fed Is Backed Into a Corner

Larry’s Note: Today, I’m sharing part of my latest conversation with Chris Lowe, the editor of The Daily Cut and Legacy Inner Circle.

September has had a rough start, and several factors could keep the market interesting over the coming weeks… particularly any updates from the Fed on its inflation target.

We also covered recession expectations. Though some big names like Goldman Sachs have eased their forecasts, we should take that with a grain of salt…

[Editor’s Note: Transcript has been lightly edited for clarity and brevity.]

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Chris Lowe: Larry, we talked a week ago in August, and you were saying when we get past Labor Day, traders are going to come back. We’re going to be out of the summer doldrums. I know we’re just a couple of days this side of Labor Day, but have you spotted any trends forming in the market in terms of stocks?

Larry Benedict: Yeah, the market is trending down. The S&P dropped a little over a percent in less than two trading days. Apple’s down like $5.50, which is huge. It did run up $10, so it’s giving back a lot of the gain. Nvidia looks vulnerable to me. The market looks skittish. It’s not off to a good September start.

If we’ve looked at bond yields, they’ve backed up significantly in the last four or five days. The 10-year note is trading above 4.26%. The prices paid number was high. It looks inflationary. The Fed meets next week. I don’t think the market’s looking for anything, but they potentially could raise rates, and that would set the wheels spinning in motion.

Chris Lowe: So tell me what that means in your head. When you see bond dealers talking about the 10-year Treasury note, it’s the benchmark Treasury maturity. What does that mean to you when you see those yields climbing?

Larry Benedict: Well, it means to me that there’s an alternative to the U.S. market. Personally, I have investments in stocks, but I’m lighter than I have been. If you look at a year ago at this time, interest rates were 1%. So if you had your money in a money market or a bank or a one-year Treasury bill, you’re only making 1%.

But right now, it’s 5.5%, which we haven’t seen in 20-plus years. So at some point, that becomes attractive for at least part of your portfolio. I know a lot of people love playing the Nvidia and they can make 40% in two days. That’s great. That’s trading, and that’s what we do. But as far as keeping money safe, bonds are not a bad alternative. So when rates are going higher, you’re getting more interest on your capital.

What’s interesting, the yield curve is pretty much inverted. So you can get 5.50% on a six-month bill, or even a little higher, but if you were to buy a 10-year note or even a 30-year bond, you’re only getting 4.25-4.5%.

And a lot of the reason for that is that 5.50% return for one year is only one year. For 10 years or 30 years, though, they’re expecting the economy to slow, for things to change, and for the Fed to stop raising rates and then start easing rates. Originally, when we came into this year, three cuts were put on the table. Obviously, there have been none. And there were one or two raises priced in.

So that was the big trade of the year, countering that and saying, “Hey, there’s no way the Fed is going to ease.” And now we’re going into next year, and it’s looking kind of flat, that they’re not going to do anything.

I do believe that we will have a recession at some point in the next six months to a year, and then the Fed may change what they’re doing. But they’re kind of backed into a corner in the sense that they have a 2% inflation target, and that’s just very unattainable.

So unless they go to 3%, or in that area, they’re not going to get the signal to make a move. But that could be an interesting wildcard in the market over the next six months to a year – the change in what they are considering an acceptable rate for the consumer price index (CPI) or core inflation.

Chris Lowe: I saw that Goldman Sachs cut their chances of a recession to 15%. You don’t seem to be on board with that. That’s kind of a bullish statement because before the recession expectations were a lot higher. So some folks are starting to say, “Look, we’re not going to get that recession.” But you still think we will?

Larry Benedict: It is quite possible. The crazy thing about the U.S. stock market and markets around the world is they’re ever-changing. And the bottom line is you got to take advantage of the ever-changing landscape in the marketplace.

The Invesco QQQ Trust Series 1 (QQQ) is up 43% for the year, and Nvidia’s gone from $100 to $400. So when these guys like Goldman make these predictions, I get it. But it’s really too hard to predict.

I see a lot of these wirehouses maneuvering their year-end targets after a move. So they may have a 4200 year-end target and then we go to 4,300. So they go to a 4500 target, but then we never get to 4500. So they go back to 4100. It’s a prediction. A lot of the reason that they think recession chances have lessened is because of how much the market has moved. So again, take that with a grain of salt.

I think the chances of recession are higher. We think there’s a higher probability for a recession, not in the next three months, but maybe in the next six to nine months. But I don’t think it’ll be steep, and I think the market should be okay off of that.

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