May 14, 2021

 The Fed Believes Inflation Is Well Controlled?

Inflation numbers have been in the news lately…and per the charts below…have been so for very good reason. With interest rates having essentially been at zero for the past 18 months, and with the markets absolutely flooded with practically FREE money from Congress, the Treasury and the Fed, it is no wonder that we are seeing roaring markets in seemingly everything…in Stocks,  Commodities, Housing, Services, and yeah, what I’d call, “Crypto Anything.” In my view, as the USA and World Economies ARE now RAPIDLY expand out of the COVID crisis, together with what appears to be rampant speculation on any number of fronts, IT IS NO SURPRISE THAT WE ARE SEEING SHARPLY RISING PRICES FOR JUST ABOUT EVERYTHING.

What is surprising, however, are the Fed’s recent comments that they THINK the inflation we’re seeing is “transitory,” and therefore, is nothing to be concerned about, meaning, they THINK there is still no reason to begin raising rates…that is, to start “hitting the brakes.”

Whether it’s Volcker, Greenspan, Bernanke, Yellen or Powell, all of those Fed chairmen would readily tell you that they, “DON’T know what is going happen,” with inflation or the economy…that what the Fed does, like everybody else, is try to figure out the future…BUT…like everybody, sometimes they DO get it wrong…with one major example being, as I have previously noted, the FACT that nobody at the Fed had ANY idea that the Mortgage Crisis was about to send the United States into The Great Recession…Or more specifically, with Interest Rates, including Mortgages, being their number one “product”, they still didn’t see the Brokerage and Mortgage Banking Industries precipitating the then biggest global economic contraction since The Great Depression. So, let’s get real…That singular “miss” IS proof enough that they DON’T know what’s coming. And believe me, I’m not sitting here saying they’re a bunch of idiots…They’re not…But one more time, they, like everybody else, are always GUESSING…and on a routine historical basis, they DO get it wrong. They DO suddenly have to say, “Whoops! We need to change the plan. And we need to do it NOW.” And then they start playing catch up, or in what I believe is the current case, suddenly conclude, “Rates need to rise…and we mean ‘since yesterday’.”

So here’s what the inflation picture looks like right now, at the Producer and Consumer price levels…And importantly, what it looked like 6 years ago…the LAST time that the Fed started raising rates…And you should need no help in recognizing that “inflation heating up” does describe where we seem to be.

Here is a bit of longer term perspective…

I know what the Fed is saying publicly, that the inflation we’re having is “transitory” (temporary), but when I look at the size of the advances we’ve seen, I think SOME alarm bells MUST actually be going off at the Fed…I mean, SOME of those guys have GOT to be thinking, “Whoa! Some of this could be getting out of hand.”

 It takes time for any Fed actions to actually do anything…

And when you throw in the conventional wisdom that it takes at least a year for rate moves by the Fed to actually have an effect…? In other words, they don’t just say, “We’re gonna start raising rates,” and see it immediately affect anything in the immediate real world…Trillions of dollars of projects are already in progress and those projects DON’T stop…So what really gets affected are plans that businesses might otherwise have been devising a year out in the future…which then potentially get reconsidered, or halted (IF rates have risen enough). In reality then, the Fed DOES have to act pre-emptively, and when they don’t, the expression that “the Fed has gotten behind the curve” becomes quite accurate…And this can mean that they find themselves in the position of suddenly having to move quickly…and BIG…which I do think has become a distinct, if not inevitable, possibility…wherein we end up getting a Federal Reserve Board announcement that becomes something like, “We have REVISED our forecast. And we believe it is imperative that we move quickly.” AND, as I keep noting, THE FUTURES MARKETS WILL TYPICALLY HAVE MOVED LONG BEFORE THEY DO.
 

I CONTINUE TO ANTICIPATE, AND BET ON HIGHER RATES. I CONTINUE TO RECOMMEND BUYING PUTS IN THE MARCH 2022 EURODOLLAR CONTRACT.

And to clarify…This is not the Eurocurrency. This is not the U.S. Dollar. This contract only reflects movements in LIBOR, which is THE international standard for short term (90 day) interest rates. Instead of Eurodollars, they really should just call this “LIBOR Futures.”

And finally, THIS CONTRACT GOES DOWN WHEN INTEREST RATES GO UP.

And yes, these are big numbers...but they are real...These puts are so cheap due to the fact that NOBODY expects this to happen...But the bottom line IS that if we get just ONE 1/4% bump in rates, at ANY time in the next 10 months, this contract WILL be at 99.50, and every 10 of these puts will be worth $6250. Obviously, if we stay right here, they will be worthless.

I have also concluded the following: The purpose of raising interest rates IS to, “Hit the Brakes.” And when I think in terms of what sort of rate increases will be necessary to be truly effective in that respect, I can not imagine that taking rates from 1/4% to 3/4% is going slow anything at all…Which then begs the question, “How high DO they need to go?”, and I honestly can’t envision that number, really, of being anything less than 2%...and even then, I’m not even sure that rate would achieve the needed result…The point is, I am in this trade with an objective that reckons with a 1/2 to 3/4% increase in rates, but the reality is, there might be, eventually, much more than that.

And this is how I see this beginning to happen…SOME coming report…on Jobs, or GDP, or Inflation is going to just HINT that this idea of “transitory” inflation is potentially in error…and the markets are going to immediately grab the idea that higher rates are NECESSARY…and go hard with it. And if this does become the case, at ANY moment, say, in the next 2-3 months, what we’re NOT going to hear is the Fed answering with, “Maybe next year.” Not a chance in my opinion. They WILL be, pretty much then and there, saying, “Okay guys. Time to go. We have waited too long.” I mean, really, let’s face it…Rates ARE going up…It’s not “if”, it’s just when, and I believe it could begin any day, week or month now…which is precisely why I want to own these options out in March, now, while, my view is  they can’t get any cheaper than they are today…but they CAN become more expensive…and quickly so…I might be dead wrong, but my very definite feeling is, as I said before, just give the markets a HINT that rates need to rise…?And Eurodollars could, within the same day, or two, be down 10-15 ticks (to start the move) and these options, at 4 ticks right now, would almost certainly be jumping up to 8 or 10.

I see this as a great bet…with a ton of time and a lot of leverage. I urge you to contact me and do SOMETHING with it.

And btw, this week saw Soybeans close 80 cents off their high, Corn close 80 cents off its high, and Feeder Cattle close about 10 cents off their low. I firmly believe all three markets have seriously reversed, so if you have any interest in getting on them, I encourage you to go ahead and do so.

Thanks for reading…

Bill

770-425-7241

866-578-1001

All option prices in this newsletter include all fees and commissions. All charts, unless otherwise noted, are by Aspen Graphics and CRB.

The author of this piece currently trades for his own account and has a financial interest in the following derivative products mentioned within: Eurodollars, Feeder Cattle, Soybeans