The Federal Reserve lacks confidence. With ongoing doublespeak in its statements and speeches, this is apparent.
See, when the Fed releases its policy, it includes a statement that details the reasons for its decisions.
And in its most recent release two weeks ago, the Fed mentioned the possibility of cutting rates twice.
But while the Fed noted that job gains have “moderated,” it also said the economy was expanding at a “solid pace.”
Some speculate that could give the Fed reason to hold off on cutting rates. The Fed also said it would assess incoming data, outlooks, and risks before any change of rates.
And while the media buzz was focused on when rate cuts would happen, you should know that such a tepid statement showed the Fed’s lack of confidence and conviction.
Now, as a former Wall Street banker who’s spent the past three decades following Fed statements, data, and posturing… I’ve learned to cut out the noise.
What I was listening for was something else… in the form of real evidence that the Fed was backing off its current policies.
But more on that in just a moment. First, let’s unpack the Fed’s lingo.
Pulling Back the Curtain
If you’ve been following me this past year, you’ll know I don’t expect rate cuts until the second half of the year.
So, you were already ahead of the mainstream when the Federal Open Market Committee (FOMC) – the Fed group that sets monetary policy in the U.S. – held its first meeting of 2024 two weeks ago.
At that meeting, the FOMC kept rates at 5.25–5.5%.
But interest rates are not the Fed’s only policy tools. The Fed also distorts the economy through quantitative easing (QE) and quantitative tightening (QT).
With QE, the Fed loosens the flow of money. With QT, it restricts it. Wall Street thinks of it as turning the money-printing taps on or off.
The Fed uses QE to buy bonds from the big banks using money it prints. This increases the banks’ liquidity. QE is how the Fed’s book grew by nearly $5 trillion in the wake of the pandemic.
After the pandemic, the Fed switched to QT. That means it’s been working those levels down. Its balance sheet now sits at $7.6 trillion, down from $9 trillion at the pandemic peak.
Through QT, the Fed chose to let the bonds on its book mature while not buying new ones to replace them.
The Fed announced it would do this last March. That’s because if it sold its bonds into the market too fast, the value of those bonds would sink quicker.
But when you manipulate money, there’s a price to pay. And that’s what we saw last year.
Printing Money Has Real Consequences
As the Fed raised rates and then kept rates high, the world of finance felt a real squeeze.
Banks were the first to crack. I wrote about the three large banks that failed last year. They were Signature, First Republic, and Silicon Valley.
They went under because the value of the Treasury bonds they held fell on the back of the Fed’s rate hikes.
As those Treasury values dropped, depositors took their money from their accounts out of fear their bank(s) would go bankrupt.
The banks couldn’t raise enough money selling their Treasurys to cover the depositors who were running for the door.
Now, as rates remain higher for longer, more regional banks could begin to feel the squeeze again.
Credit card delinquencies and net charge-offs (losses for banks) have risen. And, as we saw when Citizens Bank failed in November, Fed policies can lead to real, negative repercussions, especially for regional banks, that can take some time to play out.
The Fed is aware of this. And it’s concerned about the shock it could send throughout the global financial system if it does not achieve the “soft landing” it wanted.
This is why my research shows that the Fed will wait until the second half of this year to cut rates.
But before then, the Fed could still deploy some form of QE to protect faltering banks. That would mean more money printing before rate cuts. It could even mean stopping the QT policy of not replacing bonds that mature.
As Chairman Jerome Powell said at the end of his discussion in January, “That’s why we keep our options open.” He also warned that it’s not likely the Fed will have enough confidence by March to move rates.
Now, with the Fed holding rates steady, the next signal comes down to what Powell said to reporters two weeks ago.
The Real Story Behind the Fed’s First Meeting of 2024
After the January FOMC meeting, Powell stressed the Fed’s focus on its dual mandate.
Remember, that mandate is to ensure maximum employment and price stability. For the Fed, “price stability” means bringing inflation back to its 2% goal.
Powell warned that “inflation is still too high” and “the path forward is uncertain.”
But, on the flip side, he said it will be appropriate to dial back policy constraints “sometime” this year.
Those two statements are not only in conflict with each other but show no real conviction.
This matters because Powell said the Fed won’t cut rates until it has more confidence that inflation is moving to a sustainable 2%.
He noted we’ve had six months of “good” inflation data but questioned whether it sends a “true” signal.
But the real kicker came in two parts. And this is what the markets and Wall Street are watching…
First, Powell said the FOMC is getting to a point where questions begin to focus on the trillions of dollars on its balance sheet.
He said there were some Fed officials behind closed doors raising the issue of turning on the money-printing taps again with QE. And that they would begin more in-depth discussions at their March meeting.
Second, and more importantly, he said he sees rate cuts and the balance sheet (or QE) as independent tools.
This is a big deal. It signals that QE could come before rate cuts. That means the Fed’s balance sheet could grow again before cuts happen.
Heads You Win, Tails You Don’t Lose
Now, markets like two things above all.
First, they want cheap money to flow into financial investments and send shares of companies higher.
Second, they want certainty over the Fed’s timing. It helps them understand how to time getting cheap money as fast as possible.
That’s why rate-cutting cycles coincide with stock market increases.
And that’s especially true for the tech sector, where companies often rely on cheap financing. That financing is cheaper when interest rates are lower.
We saw this play out in the last two rate-cutting cycles.
When the Fed cut rates in 2008, the tech-heavy Nasdaq 100 Index rose by 22% the following year. The S&P 500 gained “only” 8%.
Something similar happened when the Fed cut rates in 2020. Over the following year, the Nasdaq went up 50%, while the S&P 500 gained “only” 27%.
I expect we’ll see something similar this time around.
And the best way to take advantage of the Fed’s eventual pivot to looser monetary policy is to buy the Invesco QQQ ETF (QQQ). It’s a fund that tracks the Nasdaq.
But I don’t suggest diving into QQQ all at once. Instead, invest in increments or by “averaging in.” That means you allocate your investment into four different parts.
That way, even if negative events hit the markets or data arises that shifts the Fed’s timing, you can still profit from rate cuts or QE as they approach.
Think of it as a “heads you win, tails you don’t lose” scenario. That’s one way to play both sides of the Fed going forward.
Editor, Inside Wall Street with Nomi Prins