Crypto News: Here's what a Fed on hold indefinitely means for your portfolio

On FOMC decision day, it feels as if US central bankers' policy path has already been priced in. With bond losses likely capped, this might even be a buying opportunity. Earnings reports show equities shouldn't be under undue pressure, either. The risk, of course, lies in the potential pinch from above-target inflation — and higher-for-longer rates.

It would be shocking if I started today's newsletter without having the Fed squarely in focus. But the truth is, the Federal Reserve's more hawkish "indefinite hold" policy path has been discounted by markets to the point that I am starting to see upside in bonds again. I expect Fed Chair Jerome Powell to give us nuance on that policy but nothing we don't already suspect.

For me, then, the focus is on US (and global) consumers, as we are near the tail end of quarterly earnings. The prognosis, while generally upbeat, has enough kernels of doubt around the health of the consumer to kindle worries about the longevity of this no-landing US economy. Increasingly, we are moving from a world where interest income lifts savers and creditors to one where debtors are hurt by the double whammy of high interest costs and stubborn inflation.

Many companies have pointed to consumers' wariness in quarterly earnings commentary. So all it will take for the economy to stall is for goods prices to re-accelerate. Overall, though, I come away from this earnings season upbeat about the prospect for further gains.

Let's start with the Fed, as we'll get some definitive guidance very shortly.

Earlier this week, I pointed out that markets started pricing in a Fed pivot a lot earlier than the December date everyone remembers because soon after the last rate hike in July, Atlanta Fed president Raphael Bostic — who at the time was a non-voting member of the Federal Open Market Committee — started to talk up the concept of an indefinite hold.

And this makes sense if you consider him a more dovish member. The way I remember it, when the Fed started raising the fed funds rate, the policy outline was commonly seen as a creation of then-Fed Vice Chair Lael Brainard, the leading dove on the FOMC at the time. The point was to hike quickly to catch up and then to hold. The accelerated pace satisfied the hawks and the hold at the high plateau after a "cumulative" tightening would satisfy doves. Bostic even talked of holding for 12 to 18 months, if I remember correctly.

Swaps markets that show market bets on likely future fed fund rates peaked in September for the predicted December 2024 fed funds rate just above the prevailing level, demonstrating a concern that the Fed could just keep hiking. But as chatter increased from Bostic about an indefinite hold and from Dallas Fed President Lori Logan about rising real yields in markets doing the Fed's work for it, the yields on those bets tumbled.

Mind you, there has been speculation about when the hold would end and how many cuts would come soon afterwards, with Treasury yields gyrating to reflect it. But the policy shift was done in July, advocated for by Bostic soon afterwards and then confirmed by Powell a few months later. It's an indefinite hold.

The thing about the indefinite hold strategy is that it is highly data-dependent. Until inflation gets close to 2%, there won't be any rate cuts. And only if the employment outlook starts to weaken would the Fed even contemplate cutting before we get below 2.5% or so.

By some measures, the running average inflation rate over the back half of last year was actually below 2%. And that brought the Fed's preferred measure of inflation down to 2.4%, within striking distance of its 2% target. That was good enough to expect cuts, but only if people were starting to struggle getting jobs — which early in the year seemed to be the case. Since then, though, both inflation and the employment outlook have turned up. And so that's put the Fed on hold indefinitely.

I expect Fed Chair Powell to address this directly. The binding preconditions for a cut are first and foremost about jobs. If unemployment isn't increasing and jobs are plentiful, why cut rates? Just hold. And if inflation isn't near to 2% and moving down to that level, then the Fed definitely won't cut. In other circumstances, they might even hike rates. Though Powell doesn't want to get boxed in to specific dates, I do expect him to outline something along these lines and say that the data as they look today mandate the Fed to be on hold indefinitely.

Of course, we know that already. Swaps markets are only predicting one quarter-point cut this year, with an option for a second priced in just in case things worsen. That's darn close to pricing in no cuts this year. And while we could get to a no-cut pricing, it won't move the needle that far. Maybe US two-year yields get up to 5.25% from 5% now. That's pretty limited downside for investors. Frankly, two-year Treasuries look pretty attractive here.

Remember, we're in a hike-and-hold policy regime now. There's a very high bar for the Fed to resume hikes after being on hold since July. You'd get a bunch of dissents on the FOMC and Powell isn't going to want that. So we can assume that in almost all but the most inflationary of circumstances, rate hikes won't happen and the bias will remain toward cutting. Given this backdrop, any yield over 5% looks good anywhere on the curve.

60.9%

The percentage of firms surveyed by the Institute for Supply Management saying prices paid increased in April

Now, let's turn to equities. Nvidia won't report for a few weeks but I am expecting big things. The logic I outlined three months ago still holds: Everyone and his sister is pouring money into artificial intelligence. Any company that's leveraged to that space has a tailwind on growth for quarters to come. And we need look no further than Amazon to see this.

Amazon Web Services (AWS), which is the Amazon business most leveraged to AI, beat on the top line and had the largest profit margin, nearly 40%. That's an insane margin for any business. And since both margin and revenue are growing, earnings from AWS are growing even faster.

Contrast this to Meta Platforms, which gets the bulk of its revenue from ads on Facebook and Instagram. There the company beat estimates but shares tumbled. Why? This quote sums it up:

"The disappointment on the revenue side is overshadowing any optimism about AI," said Jack Ablin, chief investment officer at Cresset Wealth Advisors. "It's hard to tell what the benefit will be to users, and while AI could ultimately mean some cost savings down the line, that isn't visible yet."

Meta beat the street because of "old school" revenue, not from AI. So I guess it's a has-been? That's the message from investors at least. For companies, it underscores how much AI is driving the current rally and incentivizes them to make proper investments in the technology, lest they receive the treatment Facebook co-founder Mark Zuckerberg did. This, of course, only helps propel companies like Amazon or Nvidia, which are genuinely leveraged to AI, to new heights.

With a lot of Big Tech and banks having reported, the sense I get is that the engines of growth from innovation and credit are still intact enough to maintain the bull market. With yields going up, future cash flows are worth less in today's dollars. But the prospect for those cash flows to be greater more than overrides that impact, at least for the companies with future-oriented earnings reports. This is why stocks overall actually do well in an environment in which yields are increasing, especially high-beta companies with backloaded earnings profiles.

What's the wrinkle? It's two-fold. First, there's the high rates piece. And then there's the related but separate issue of consumer fatigue.

On rates, I've been an advocate of the sometimes-derided view that higher rates can be stimulative. The case is pretty simple really. If monetary policy is to be restrictive by making borrowing more onerous, then the more onerous borrowing by debtors has to override the more favorable interest income from savers and lenders. And in an environment where the Congressional Budget Office says "the deficit amounts to 5.6% in 2024, grows to 6.1% in 2025," you're not going to see that. There is simply too large a net transfer of financial assets to the private sector from the federal deficit to think borrower pain will outweigh creditor joy.

Even so, debtor distress is real. For example, the percentage of credit-card bills past due in Q4 2023 was already higher than at any point since 2012. In the last GDP report, the imputed personal savings rate was just 3.2%. These are telltale signs of simmering financial stress. At some point, without rate relief, this will spill over into consumer fatigue and act as a brake on growth. Given the huge pick-me-up from federal deficits, the question is when.

But since we're talking about consumer fatigue emanating from debt interest payments, we should also discuss the pernicious impact of resurgent inflation too. The headline of Wednesday morning's ISM Manufacturing Survey was the sluggishness revealed by only 49.2% of businesses reporting growth. The highlight, however, was the nearly 61% of businesses reporting higher prices paid.

Recent commentary from Apollo Global Management's Torsten Slok suggests we could see goods inflation re-accelerate, adding to a sticky services inflation that will stretch the paycheck of average wage earners even further. That is inflation that will feed through to consumers to act as a second source of stress on family budgets.

The US economy is still growing above trend but with cracks that can't be ignored. We're still in a no-landing world that demands the indefinite hold strategy the Fed is now delivering. In fact, the central bank's forward guidance since December probably contributed to some of the loosening of financial conditions and overheating we've now seen. So, the Fed's latest guidance will help the economy find a level more consistent with slower inflation, and is a much-needed course adjustment.

Overall, that's a decent backdrop for bonds and equities. Recent firming in data out of Europe only add to the upside prospect for companies with global ambitions. On the bond side, it's the fact that inflation would need to go to 4% or 5% before we got hikes that limit downside risk. With the fed funds rate at 5.33%, that means 5.25% is a likely hard upper bound across the curve. The closer we get to 5% at the back end of the curve, the more incentive investors will have to lock in yield — a major reason we haven't seen long rates catch up to shorter-term ones yet.

On the equities side, as long as the economy keeps going, we should expect companies with the most backloaded earnings prospects to continue to lead the charge. Those that falter because of poor execution or a lack of earnings leveraged to future trends will be punished ruthlessly by investors. But I would caution that this is exactly the scenario that will mean a heavy sector performance rotation when a recession hits. When everyone has piled into growth as far as the eye can see and the economy turns down, the whiplash will be extraordinary.

Sorry to end my upbeat views on a sour note about sector rotation whiplash. But the reality is that risk-taking has become severe. So, quick question here. Short-dated options are presented as a tool to hedge or speculate on event risks, such as this week's Fed decision, though some are worried about their side effects. What's your opinion of ODTE? Would you support expanding their use to individual shares to allow traders to make more targeted bets on developments such as corporate earnings? Share your views in Bloomberg's MLIV Pulse survey.

"Before the pandemic, companies were marching to modernize their infrastructure, moving from on-premises infrastructure to the cloud to save money, innovate at a more rapid rate and to drive more developer productivity. The pandemic and uncertain economy that followed distracted from that momentum, but it's picking up again."

Andy Jassy

Amazon CEO

The latest jobs openings data point to weaknesses that explain the Fed's easing bias.
Increased stock buybacks will help earnings per share increase even if actual earnings come up short.
By the way, Bloomberg has a very cool way of using a natural language processing model to predict the Fed Chair's next move. Can I call that AI?

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