And in this corner… 

Well, the stage is set. The participants have been selected and the battle is officially on. It’s the  Fed versus market participants now. What are the reasons for battle you ask? The Fed is hell bent now on raising rates, they are sending out various Fed Governors to politely “hint” that they  are not pivoting as the market perceives them to be. The blow-out jobs report on the 5th (528k  jobs created versus expectations of 250k and an unemployment rate dropping to 3.5%, wage  growth accelerating 5.2% Y/Y) was not what the Fed wanted but now gives them an even  larger incentive to raise rates. The current Fed Funds Futures now shows a 65% chance of  another 50bps hike in September. But 75bps is not out of the question; nothing is right now. The  Jackson Hole symposium on August 25-27 will be highly scrutinized for further clues. 

The second combatant is…you, as in market participants. Who, despite looking straight into the  eyes of a fierce opponent with literally unlimited resources (i.e., Fed), have chosen rather to defy the ultimate rule when engaging in battle: “don’t fight the fed!”. That hasn’t proven too successful in the past (long or short) for those wishing to tackle this beast. But maybe it’s different this time?  

Ever since the Powell pow-wow on the 27th, the market has stuck its proverbial middle finger at the Fed and just keeps hitting the buy buttons – heedlessly ignoring the steep rate hikes and likely now disregarding the more aggressive quantitative tightening coming in September, in which the Fed will double its runoff from $50 billion to $95 billion which equates to an annualized pace of $1.14 trillion.  

Another reason the Fed may become aggressive is the fact that speculation is back! What do we mean and why does that matter? During the past few weeks, we have seen the once left for dead, but now back on center stage in the main room, short squeezes come back in fashion. AMTD Digital, Beyond Meat, Carvana, and even Gamestop and AMC have staged massive rallies on the backs of high short floats – reminiscent of the summer of 2021 when rates were low, and QT sounded like the latest fitness fad.  

You may be asking, why does the Fed care if AMC goes up 46% in 6 days or Reddit message boards are pumping Hong Kong-based trash stocks like AMTD Digital? They do, trust us. The Fed has plenty of scars on its back from all the arrows flung at it blaming them for creating speculative bubbles (NFTs, AMC, Dogecoin, etc.), and now that the speculation has returned despite the hawkish actions and tone…well, now you are just mocking them.  

Inflation has cooled some as registered by the CPI (8.5%) and PPI (9.8%) this week– both came in lower than expected, which aids the “peak inflation” narrative. But both are at approximately the same levels as March when equity markets were freaking out over inflation. 

Also, the core CPI currently stands at 5.9% – still almost 3x higher than the Fed’s target of 2% (good luck with that).  

It is shaping up to be a most interesting fall. Seasonality dictates some weakness ahead, and the  Fed ramping up their fight only reinforces it. But, as we have seen this month investors are ignoring the Fed, the wonky economy, and still elevated levels of inflation. In addition, there are now increasingly large amounts of underinvested hedge funds watching the market rise from the sidelines with racing levels of angst. Also, the CTA community has been actively buying equities as the trend following the herd is now bullish.  

But we would defer to the balance sheet below that is currently retained by the Fed and ask how the increased attempt at reduction starting in two weeks will affect liquidity and assets for the remainder of 2022.  

We would also point out that the 10-year yield rose 13bps to close at 2.87% this week which is near a 4-week high. Maybe the rate markets aren’t quite as benign on inflation expectations as equity investors are.  

Choose your sides, folks: the battle is on. It certainly IS an interesting time.   

The current Fed balance sheet stands  

at $8.8 trillion. That’s a lot of  

reduction ahead to even get to pre 

pandemic levels – which is the grey  

shaded bar.