Analysis of Fed Policy and Market Moves at the end of 2024

It was an interesting week for markets.

On Thursday, Powell collapsed the S&P 500 by about 3%, quite a lot for a single day. WTI oil futures were down about 2.5% and copper down about 2%. The co-movement downward of these three series point to a downward plunge in expected NGDP growth: the theoretical, unseen variable Market Monetarists use as an aid in thinking about monetary policy.

I’d been expecting Powel to tighten, simply because he keeps saying he wants 2% inflation, everyone seems to agree that 2% is a reasonable inflation target, and with 5-year TIPS spreads at 2.4%, and measured inflation coming in well above 2%…well it seemed we needed tighter money to hit the preferred policy target.

To prepare for tighter money/slow NGDP growth, I’d been building a TLT position since the summer. Not exclusively, I’ve been building many positions, especially Argentina, but yeah, I bought some TLT every week. My reasoning was that lower NGDP growth usually means lower long rates. If NGDP slows, then eventually the Fed Funds rate (a short rate) has to come down. Long rates are a forecast of future short rates, and if the short rate comes down, that implies a lower short rate in the distant future, hence long rates also tend to come down.

There’s also the aspect of “DOGE”. Musk seems to be the representative of the Silicon Valley gods in the Trump admin. They seem to want a serious fiscal correction. Assuming they get that, well then “G” in the GDP formula goes down, and well you need a lower policy rate so the private sector can pick up the slack. The opposite of the Deutsche Einheit scenario.

So I figured long rates would be coming down. But weirdly, the bond market did not react to the Powell tight money announcement as expected. The 5-year TIPS spread is still at 2.34% and long rates actually went up. It is like the stock market and the bond market are operating with different information sets. Stocks screamed “lower expected free cash flow” i.e. “lower NGDP” but bond markets seemed to have no real NGDP growth rate forecast response, and instead simply predicted slightly higher policy rates in 20 years time.

The default assumption should be that markets are right, and have done a better job of processing new information than you (or I) have. Still, markets are composed of mere mortals. A year and a half ago you could buy Palantir shares for $6. Markets are only as good, and as brave, as the people in them. I’m not on Wall Street, I have no idea what the median bond trader is thinking. Who knows, they might not be that bright and the bond market is temporarily inefficient.

It’s possible I have something wrong and long rates are right where they should be, given what we know about the economy and the Fed’s true goals. Still, with 5-year break evens over 2.3%, various measured inflation series coming in generally “too hot” in recent months, and the prospect of fiscal tightening, well I say all rates are likely to come down. For the same reasons, stocks are still vulnerable to an unexpected, monetary policy driven, reduction in free cash flow growth.

I’m going to continue to sit on my sizable TLT position. I don’t expect it to offset losses on stocks (which I am NOT selling) if policy is tightened. I do hope it will soften the blow, and give me an option to average out of TLT while markets are plunging and over-correcting, and into my favorite equities. If I am wrong, well then I’ll live to tell the tale as long rates probably aren’t going to go up a whole long more, and I can soak up some yield and tell myself insurance isn’t free.