When 50bps is bullish
The fed, Unity, Meta, and commodities
This past week was a lesson in why the macro disclaimer is always needed. I said last week that a hot-ish CPI print was bullish for equities, that the market needed it, and it should lead to locking in a 25bps cut. Well I nailed that pretty much on the dot in terms of the call. Except the market decided to sell off close to 1.5% first after the print because suddenly people were scared the Fed is going to make a policy mistake. So if you, like me, went into Wednesday’s print pointing bullish, if you carried too much leverage its likely that you sold lower, trying to stop your losses. Which in term causes more pain when you see the market rip higher.
I bring this up to again restart that you should have a macro framework but trading macro data is an exercising is running through an active minefield.
Forgetting about CPI, the 25bps cut odds shot up to ~85% by end of day Wednesday. We’re in the Fed blackout window, so that should mean that we’ve should be done with any surprises. That didn’t stop Nickki leaks and Dudley from putting on trial balloons on a 50bps cut. By close Friday were back to 50/50 odds. Which is the most indecisive any Fed has been ever since they started forward guidance.
It’s all so tiresome. Listen I’m firmly in the camp that the Fed is incompetent, meaningless, and net-net bad for all aspects of government/financialization/the United States and its economy. There are few redeeming qualities of the Fed and none of them are worth the amount of money US tax payers pay for these services. Saying that this current Fed/recently retired Fed officials are even more asinine than ones in the past. I mean Mary C. Daly still has a job. After overseeing the biggest banking crisis since 2008. She has shown she’s terrible at the original and central purpose of the Federal Reserve stopping banks from blowing up and causing systematic issues. Yet she still gets to show up and act important.
So now we’re here. Honestly the rate cut on Wednesday does not matter…..well let me rephase, its a known entity. What we don’t know is what the future post rate cut world looks like. I’m in the camp that the consumer is getting stronger and feeling more confident and couple that with even minor rate cuts will lead to an explosion in spending in Q4/Q1.
The flash data is bearing that out as well. Visa was interviewed at the Goldman Sachs conference this past week that credit card spending is rebounding well above what macro doomer and bond bulls (but I repeat myself) think.
Here’s the early print of Michigan’s consumer confidence data, backing up what Visa is saying:
The consumer is feeling better, only slightly, but its the second month in a row that they’re feeling an improvement. More importantly, while the current economic conditions are viewed as not great, forward expectations are amazing. Up 11% yoy. That’s going to get people spending. Why? Because as I’ve talked about at length if people feel comfortable, like they don’t need to worry about layoffs, like a promotion might be coming, they’re going start spending more. Not just on fluff stuff either. They might spend an extra 200 - 500 a month on a mortgage payment, or buy a slightly bigger car, or maybe think about having that second or third kid.
This all points to growth inflecting upwards. More importantly it points to a not-recession. Which is something that is currently being priced into the depressed yields on the 2s and 10s. The other major component of the lower yields? Deflation.
Listen, I don’t want to get super political, but the two biggest deflationary impulses since 2021 are either seeing diminished returns or possibly outright reversals soon. Illegal immigration/whatever you want to call what’s happening on the southern border will stop/massively slow for sure under one POTUS candidate. The other might be forced into supporting that policy as well just for her to have a chance of winning. Immigration as a whole is deflationary, but at speed and gusto it’s been done in the last 3 years has put a cap on wage growth which stalled out the wage price spiral.
Listening to the candidates debating this past week both want to flush the economy with money. What will be able to get through congress is a little more complex, but the intent is there. Both sides will have to deal with the southern border in the next four years, as its a top 2 issue for most voters. If you add less illegal immigration + money bazooka together, inflation might not come back, but deflation will be killed.
On China, they’re clearly waiting until the Fed starts cutting to do any real stimulus. What that might look like, I don’t know, but they need to fix their economy given the state of youth unemployment (remember youth are rabblerousers and could actually threaten the CCP’s power). So something is coming. If they’re able to get their PPI back to positive, that’s going to create more inflation within the US, as their PPI affects our CPI almost more so than USA’s PPI does.
So back to the Fed, and the title of this piece. We know there’s going to be a cut. This upcoming week is all about optionality. What is the future optionality of cuts if the Fed does 50 vs 25. That is the key to unlocking if a 50bps cut can be bullish.
To keep as many options open as possible the Fed would need to do 50bps and then signal to the market that they’re going to be in a wait and see approach. The dot plot should only show limited cuts into next year. This would signal that the economy is fine-ish, but also allow the fed to cut for deflationary reasons. By doing it this way, the can argue that by front loading the cuts it allows the economy to feel the rate cuts faster. That they can still do 25bps in December/January (probably with a pause in November) and then continue doing 25bps monthly until the economy either ‘recovers’ or inflation comes back (and remember some inflation is good, inflation as a whole isn’t a 4 letter word).
Forget recession, if you think deflation is the real near-term risk to the united state economy this is likely the path you take. The benefit to doing it this way is it fights deflation quickly. They will look brilliant if deflation was/is the real problem in hindsight.
What they lose by doing this is that if inflation comes back due to pick your reasons, and the Fed will be viewed as replaceable. I don’t even mean the Presidents will just be replaced either. Both political parties have had reasons to hate the Fed in the last 8 years and while the Fed claims independence you’ve had former Fed Presidents openly state the Fed should help/hurt one political party or another. Whatever little ‘independence’ the Fed has left (and I don’t think its a lot) will disappear.
The reason for that is simple, every senator and member of congress will ask ‘why did you cut 50 vs just 25 when inflation despite looking like it was rolling over wasn’t dead and you were just hoping it would continue’. The non chairmen Fed members don’t like to talk to congress critters much, instead of only speaking at various economic brunches and other meaningless will-never-be-confronted-by-outside-thought events, but make no mistake they will have to answer for this if Inflation re-spikes to 4, 5, 6, 7, 8%. And suddenly short term rates will spike and be held up there until we’re firmly in a recession, the Fed won’t be able to do preemptive cuts the second go around.
Whereas the 25bps cut gives them the ability to pivot easily and raise rates. It also gives them the ability to cut rates faster if need be. Or stairstep them downwards. All options are still on the table. The 25bps cut is bad, or doesn’t work, if we enter a massive near term deflationary wave.
The 50bps cut might be the right thing to do, but the downside risks it opens up is a lot greater than 25bps.
Okay enough about the Fed, let’s talk about some other news that happened this week. The White house made a major announcement on Friday. One that I think should’ve happened years ago. They’re going to change the De Minimis shipping rules.
The rules as they currently state allow for easier custom paperwork/processing and duty-free shipping from abroad….mostly China. This has allowed companies like Temu, Shien, Wish, and now Amazon, to benefit via less taxes paid and less expenses incurred when shipping stuff from China to the United States. This is how Temu and Shien can have such cheap prices on items, but their wait time are so long. Its not just them though, though they’re the biggest players. This exemption has also been exploited by most Amazon e-com sellers. Its why there’s 500 knockoff brands for every one serious brand, selling for cheaper ‘but the item will take 2 weeks to arrive’. How they’re able to sell cheaper, and put downward pressure on goods.
Closing this exploit will help increase tax revenues and make sure all goods are being sold on an even playing field. I think it will also put a cap on major upside of META.
Just over 2% of Meta’s total revenues came from Temu and Shien. We have to estimate a little but I think its between 2.7 - 3% of total revenue is from low cost drop shipping companies from China. This change will likely eat into these companies profits. They will respond one of three ways. Either increase spend to keep customer acquisition high (least likely), go bankrupt/stop ad spend all together (not that likely but a possibility), or cut ad spend to preserve some profit margins (my guess for most likely).
I think this will have about a 1 - 1.5% hit on top line revenue for META. I don’t think it will have a huge impact on revenue. I do think it will affect gross margins more severely. META uses an auction system for buyers of their ads. This helps lower their key customer risk but when a major buyer of all ads, which is what Temu and Shien have been the last 18 months or so, leaves the auction or lessens their buying, the price of all ads go down.
Assuming this rule change goes through, I think this could have anywhere from a 2 - 5% near term hit on their margins, which will likely last 1 - 3 quarters as the market place resets.
The thing with META is they’re seeing increased spend because of the election until November. Then its Christmas season. Then you’ll start to see the Temu affect. If there is one at all. This lack of visibility will make larger long only’s nervous. They won’t allocate as strongly into META because of this near term. Until at least we get through one or two quarters of commentary.
I don’t think this is bearish META, but I do think this will put a cap on the upside on META. Something to keep an eye on as we get more information.
Last I want mention Unity. Which removed the run time fee that the former leadership put into effect to try to get more money out of Genshin Impact and other free to play games. Instead they’re raising the prices on their enterprise clients. They’re also setting things up for yearly price increases. Or something close enough that even assuming similar numbers of customers their revenue growth should start to trend positive around 5 - 8% at least. With upside risks if any of the games created on their platform become hits. The stock responded by ripping up almost 15% in two days.
I think its worth going long in the mid 18s, with an easy target being 21 - 22. I talk more about it in my weekend video, which you can see here.
Coming up this week is a discussion on water, and we find out what the Fed is going to do.
Woooo, water gang!
I agree that the consumer is strong and improving. You didn't mention oil / gas prices at all, yuge Impact on consumer as well.
I'm expecting a 50 bps cut.