Trade The Journey

Trade The Journey

The Fed raises by Twenty-five basis Points!

Top of the Morning Fed!

This week, the Fed rate announcement was on my mind as it was for everyone else involved in the markets. The consensus was for a twenty-five-basis increase with a small probability of a pause in rate hikes. I traded during the last rate hike announcement and press conference and it didn’t do well but that didn’t stop me from trying again.

This time, I decided to watch the position through the statement release and press conference. Most of the movement that occurred in my position happened while Chairman Powell was speaking. This time I set a profit target and when it was reached, I closed the position, marking my first profitable trade in several months.

I must admit that it felt good to have a winning trade. With the winning trade, I broke even with the last losing trade. I’ll talk more about the trade in the trade strategy section or you can click here.

Economy

The only event on everyone’s mind was the Fed’s announcement of the rates and press conference. The market, through interest rate swaps, forecasted an increase of twenty-five basis points with over a sixty percent probability. Initially, most analysts were convinced that the Fed would raise rates by fifty basis points but that was before several banks collapsed and the first sign of strain emerged in the banking system.

The week prior to the Fed’s announcement, undeterred by the pending collapse of Credit Suisse, the European Central Bank raised rates by fifty basis points citing inflation as the more serious fight long term. The Fed had a significant dilemma on its hands, is further tightening warranted as things begin to break due to higher rates? Usually, I begin with the first economic data report released but this week I feel that the rate decision held precedence over the other reports, so I begin with the rate decision first.

The Fed decided to increase rates by twenty-five basis points, which was in line with the forecast. The target range for the federal funds rate was raised to 4-3/4 to 5 percent. In their statement, they cited that the labor market remains strong, and inflation is still well above its target. The Fed also will maintain its’ balance sheet runoff, although the runoff was temporarily disrupted due to the liquidity disbursements to banks.

At the press conference, Chairman Powell addressed the recent developments in the banking sector.  The Federal Reserve created the Bank Term Funding program to assist banks facing liquidity challenges. The discount window from which banks can borrow was also mentioned as another avenue for Banks to shore up liquidity. With the recent collapse of several banks and higher rates, the Fed acknowledged that tighter credit conditions will assist the Fed along with some policy firming which may be enough to quell inflation.

Although the banking situation was addressed first, inflation dominated the press conference. The median projection of the Federal funds rates remained at 5.1% at the end of this year. Tighter credit conditions should slow the demand for credit from businesses and households, helping to slow demand and in turn lower prices. It seems that the Fed is also monitoring the non-housing services sector which is 44% of the core PCE index. One of the questions posed to Powell was the oncoming commercial real estate risks beginning to rise.

Powell answered, that as of now the banking system is in good shape and doesn’t think commercial property poses risks for now. However, vacancy rates have been rising in the commercial sector due to changing work conditions, credit availability, and higher rates. According to an article in the financial times, the market for commercial mortgage-backed securities has slowed resulting in a squeeze in the ability of banks to free up lending capital. “Commercial real estate relies on bank lending – especially among the small and midsized banks.

The outlook for rate decisions seems to be towards an eventual cut, most likely next year. With so many moving parts to the economy, I don’t envy the job of the Fed chairman. Below is a chart detailing the economic projections of the Federal Reserve board members and bank presidents.

As evidenced by the chart, real GDP is seen slowing to 0.4% in 2023, down 0.1% from the previous meeting. The PCE inflation projections also rose. In the longer run, inflation is projected to return to the Fed’s target but it is unclear when.

Market participants should prepare for volatility ahead as tighter credit conditions could usher the economy into a recession. The credit cycle, productivity, and the business cycle are the three sections of the economy investors/traders should watch closely according to an interview with Ray Dalio in the Market Wizard compilation by Jack Schwager. This interview is in the Market Wizards: Hedge Fund edition. I highly recommend you read each of the books in the Market Wizards series.

One sector that had an immediate reaction to the rise in rates is housing. Although rates have moderated from the highs reached a few weeks ago, they still remain above 6%. The Mortgage Bankers Association noted that the median payment for housing rose 4.9% in February. The mortgage payment to income ratio reached a new high in February.

Mortgage applications rose 3% from the week prior. The refinance index rose 5% and the purchase index rose 2% from the week prior. The 30-year fixed mortgage rate for conforming loans fell 0.23% to 6.48%. The 30-year fixed mortgage rate for jumbo loans fell 0.09% to 6.30%. Mortgage rates rose above 7% earlier this month before dropping back to the 6% level, while mortgage rate volatility has increased slightly. Mortgage-backed securities (MBS) prices have moderated. It’s a good idea to watch the MBS market because lenders base their rates partly on these securities along with other factors.

New home sales rose 1.1% in February. The median sales price of new houses sold was $438,200, with a supply of 8.2 months at the current sales rate. The average sales price was $498,700 which is higher than the 2021 annual average sales price but lower than the 2022 average. New homes for sale at the end of the period continued its multi-month fall, while new homes sold during the period increased.

Existing-home sales rose 14.5% in February with the median existing-home sales price at $363,000. The inventory of existing homes was unchanged at a 2.6 months supply at the current sales rate. Homes typically remained on the market for 34 days, 1 day longer than the January levels. First-time home buyers fell 4% in February to 27% of sales. Single-family existing home sales rose 15.3% from the previous month.

Tighter credit conditions may further affect home sales and construction moving forward. There’s also a shortage of construction workers, so this sector has some challenges ahead.

The durable goods reports showed that new orders for manufactured goods fell by 1% in February. Excluding transportation, new orders were unchanged. Excluding defense, new orders fell by 0.5%. Shipments of durable goods fell 0.6%. Unfilled orders fell by 0.1%. Inventories rose 0.2% led by an increase in transportation equipment inventories. New orders for Capital goods, a proxy for business spending, fell by 1.2%. Capital goods shipments and unfilled orders also decreased while inventories rose.

New orders for capital goods have fallen for two consecutive months. Primary metals and fabricated metal products’ new orders have been somewhat steady.

Primary Metals: Gold, Silver, platinum, palladium, rhodium, ruthenium, iridium, and osmium. Some of the precious metals can be used as a hedge against inflation and economic turbulence while others are used in industrial processes. Precious metals are often used in high-technology applications and devices.

Fabricated Metal Products: transform metal into intermediate or end products, other than machinery, computers and electronics, and metal furniture, or treat metals and metal-formed products fabricated elsewhere. Examples include Hand Tools, Bolts, Nuts & Screws, Cans, Pipes and Pipe Fittings, Metal Windows & Doors, Equipment Attachments, and Car Parts.

The current-account deficit fell by 5.6%. The trade section showed that: Exports of goods fell in industrial supplies and materials. Exports of services rose in travel and in financial services. Exports of goods and services to, and income received from, foreign residents decreased $1.1 billion to $1.14 trillion in the fourth quarter. Imports of goods and services from, and income paid to, foreign residents decreased $13.3 billion to $1.34 trillion.

The current-account balance can be thought of as a report on the countries’ financial inflows and outflows.

Initial claims showed that the labor market is resilient.  New claims decreased by 1,000 to 191,000, which is below the forecasted 200,000 level. Continuing jobless claims rose slightly from the week prior. The four-week moving average showed that initial claims remain below 200,000.

Trade Ideas:

Commercial real estate: Bearish

Commercial real estate faces an uphill battle as employers adapted to hybrid work schedules, reducing the need for large office spaces. The trend towards this type of work environment looks to be permanent, which will affect developers in the coming years ahead. It’s also facing some headwinds due to tighter credit conditions developing as mentioned earlier in the posts.

Bonds: Bullish

Chairman Powell made it clear that tighter credit conditions will help ease inflation and may help the Fed avoid raising rates much higher as previously forecasted. A twenty-five-basis point hike is probably on the table and then maybe a pause to further assess the economic environment.

*Correction made to the Vix Chart, weekly volatility is in percentage, not in dollars. Within the parathesis is the dollar amount the indices are forecasted to move based on their volatility. Volatility does not indicate a direction, only the magnitude or speed of the movement.

 

This past week’s cash flow in review:

This past week was rough in terms of cash flow management. Money kept slipping out of my account, some due to unforeseen circumstances and some due to reckless spending. It’s been challenging managing my cash-flow on an income that’s less than my previous job. While I’m in the process of changing jobs or careers, I have decided to fund my trading account with some of the money earned in my investment account. I’ll be adding my trading results each week to this site, as well as the process I go through to find a trade.

Grade: D+

Reason: Poor money management

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