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#207: What Difference Does the Fed’s Rate Make?

#207: What Difference Does the Fed’s Rate Make?

micksonmatch
December 24, 2024

I think today will be the last letter of the year. I am planning to start early in the new year. I wish you all a happy festive season and all the best for the new year. I think 2025 is going to be wild.

S2N Spotlight

Last week the FOMC decided to cut the Fed Funds Rate by 25 bps. The natural question to ask is what is the likely impact on future stock returns.

Here is a step-by-step answer to that question. It is just one approach and interesting to observe.

We start by taking the Fed Funds Rate and plotting a regression of the 1-year forward S&P 500 return. As expected, the regression line drops as rates go higher. However, using a linear regression I believe is too rigid an approach, which strips out some of the important signal information.

To create a more dynamic approach that observes only 30% of the data points, we plot a polynomial regression. We get some interesting information here. The higher rates clearly have a negative impact on future performance. However, lower rates below 11% do not provide a clear answer to future performance.

In order to take a deeper dive, let us not look at the Fed Funds Rate in isolation, as a rate of 10% might not be high if inflation is 9%. So in the next 2 charts, I take the Fed Funds Rate and subtract the Core Inflation rate to get the Real Spread and do the same 2 regressions.

What is really interesting is the polynomial regression of the spread. A very negative spread and a very positive spread do not suggest good forward returns in the S&P 500. The current spread is in the sweet spot of future returns.

S2N Observations

People often talk about the commodity index; I wanted to share how this index is made up of many sub-indexes, each going through their own price journey. What might surprise some of you is that the Bloomberg Commodity Index is actually negative for the year. However, within the index there is a mixed bag of returns.

There was a massive swing in the net position of large speculators in the Aussie Dollar last week. From long to short we have gone. The AUDUSD is weak and heading for some serious lows. This is likely to keep inflation elevated.

There is actually so much I want to still say, but I think it is best for me to keep this brief as holidays beckon.

Yesterday someone deep in the crypto space took me a friendly bet that Bitcoin will be above $1m by 2030. I personally don’t think so. There was an outstanding article in the WSJ today discussing the threat to crypto and other industries with the pace of quantum computing development. It will be a major challenge for the so-called decentralised blockchain to consent to moving all bitcoin to a quantum secure wallet. We are not there yet, but I am pretty sure that when hackers are able to get their hands on this technology, they will be targeting this sector. Unlike the current banking system that can roll back certain transactions, good luck trying to recover your Bitcoin when it leaves your wallet. When I last looked, there was no support email or telephone number for lost passwords, fat-finger transactions, or stolen coins.

The other excellent article in today’s WSJ was the battle of 2 economic superpowers. The USA vs. China, and Trump vs. Xi. The article centres around Xi staying the course with his economic policy of building China’s supply chain from automobiles to semiconductors and the rest and largely ignoring the deflation around the collapsing property market. He is quoted to have said, What is so bad about prices coming down in property, isn’t it better to buy things cheaper?”

We will discuss China in much greater detail in the new year.