The silent guns of the Federal Reserve

Stocks eked out moderate gains yesterday as NVIDIA clawed its way to a fresh high. ISM Manufacturing came up with a weaker-than-expected print underscoring a hobbling manufacturing sector.

Eyes on the horizon. Imagine that you are a gun commander of an artillery piece. The gun is high up on a hill on the coast. You are charged with protecting the one and only harbor of your country and yours is the only gun. THE ONLY GUN. You spend hours looking at the horizon through your binoculars. You rarely see anything but for the occasional surfacing whale or a loose buoy bobbing on the waves. It is a stressful job because even though the coast is almost always clear, your country has been attacked before, though it seems like many years ago. You spend your days making sure that your equipment is in good order, polished and oiled. You run your team through drills, first gunner, then ammunition handler, then loader, then gunner again. You click your stopwatch, reprimand your crew, and repeat. No shots are fired. Why not? BECAUSE YOU ARE LIMITED IN AMUNITION. You must save every last shell for the real thing.

One day, you see a ship on the horizon. You can’t make out its flags, which concerns you, but the ship doesn’t appear to be heading towards you. Several days pass and a few more ships appear. You are on high alert. You still cannot recognize the ensign on the mast however, the shape of the ships and rake of their masts suggest that it is not an ally. The line of ships seems to be getting closer, though they are out of range. You wonder, “should I send a shell downrange to get an idea of distance and perhaps send a message to the ships that you mean business?” You look over to your ammunition handler who carefully stands watch over the LIMITED ammunition and think better of it. No, you will have to be patient and keep vigilant.

You are a Fed governor, and your job is to protect the US Economy from high inflation and high unemployment. You only have one tool to get the job done, interest rate policy. Your ammunition is limited! You can move rates slowly or quickly, but the range of rates is somewhat limited. You can go as low as 0% (and possibly, but not likely, lower). You know that rates briefly touched 20% on the upper end way back in 1980, but that “nuclear” option is off limits. No, except for that lone event, the high end is theoretically, most likely around 6%… this, according to economic experts. Inflation had not shown up for many years and your job has been primarily focused on keeping the country out of recession by lowering interest rates and then raising them slowly to build up ammunition for future recessions. In 2021, you spotted something peculiar on the horizon, but you were unsure what it was. You were patient because you didn’t want to waste any policy moves. Then, one morning you woke up and realized inflation was at your doorstep, the likes of which had not been seen in decades. You raised rates slowly at first, but inflation was undaunted. When it was clear that you were late in your response, you raised rates hard and fast leaving yourself with only two hikes to the upper theoretical bound. Inflation receded but not altogether. It is still here, but now there is a new threat. Recession… bobbing off in the distance on the horizon.

You watch carefully and you wonder if it is getting closer. You consider lowering interest rates, but you remember how low your ammunition was in the years after The Great Recession. Recession appears to be out of range, and you decide to keep your powder dry. Instead of wasting precious and limited policy moves you decide to run through drills by making public statements and bold gestures… in preparation for the real thing, of course.

It is true that the Fed was in a tight space in the years after the 07/09 recession. In 2015, the Fed began to raise rates even though the economy was on tenterhooks to build up dry powder. By 2018, the economy was struggling, and the Fed was forced to use its limited ammunition to stave off another recession. When the pandemic struck, the Fed was forced to completely deplete all its ordinance. The high inflation that followed allowed the Fed to build up its ammunition to levels not seen since Y2K. Are there threats looming on the horizon? Indeed, there are, but the Fed is in no rush to deplete its ammunition… unless the threat of recession gets too close to the shoreline. It would be nice to see the Fed fire off a few shots for good measure, however if a recession does appear, you will want the Fed to have as much dry powder as possible.

WHAT’S BOBBING ON THE WAVES THIS MORNING

Bath & Body Works Inc (BBWI) shares are lower by -8.80% after the company announced that it beat EPS and Revenue estimate in the last quarter. The company gave current quarter guidance which was below analysts estimates as sales decline year over year. 57% of analysts that cover the company rate it the equivalent of a BUY with the remaining 43% rating it a HOLD. Dividend yield: 1.5%. Potential average analyst target upside: +4.5%.

Intel Corp (INTC) shares are higher by +1.55% after it announced its next generation AI solution. The company’s estimated forward operating margin is 10.7% versus 24.9% average over the past 5 years. Dividend yield: 1.65%. Potential average analyst target upside: +30.2%.

YESTERDAY’S MARKETS

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• Earnings after the closing bell : Crowdstrike, Guidewire Software, and Hewlett Packard Enterprise.