• Inflation remains elevated (from the FOMC statement)
• The risks to achieving employment and inflation goals are roughly in balance (also from the FOMC statement)
• No one dissented to the decision

Taken together, the Fed looks resolute about what Powell explained in the press conference as “we see things as in a really good place for policy and for the economy and so we feel like we don’t need to be in a hurry to make any adjustments.” However, this decision sure felt like the calm before the storm given the bookends to this meeting with big AI headlines and tariffs.

Inflation Floating Into Tariff Pressures

Inflation’s profile continues to give the Fed reason to pause. However, Powell said the Fed sees a “pathway” for inflation getting to target. The current downtrend in inflation for owner’s equivalent rent and housing services continues to exert downward pressure on overall inflation. However, for now, the downtrends in core CPI and PCE have essentially stalled since last summer. Powell is fond of explaining “we want to see further progress on inflation” and further progress has not happened for several months.

Sources: U.S. Bureau of Economic Analysis, Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index) [PCEPILFE], retrieved from FRED, Federal Reserve Bank of St. Louis; U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items Less Food and Energy in U.S. City Average [CPILFESL], retrieved from FRED, Federal Reserve Bank of St. Louis. January 31, 2025.

While there is reason for optimism that inflation will eventually float downward to target, other forces are brewing that could disrupt the narrative. At the time of writing, the U.S. announced blanket tariffs on three of its major trading partners. Starting February 4, the U.S. will charge Canadian and Mexican imports a 25% tariff, with a reduction to 10% for Canadian oil. Chinese imports will have a 10% tariff. The announcement even includes an escalator in case of retaliation. Canada has already promised retaliation with a 25% tariff on various U.S. goods. While there is some unconventional thinking out there about the economic impact of such broad-based tariffs, I am leaning toward more, not less, inflation from all this economic warfare.

Bond Vigilantes Calm for Now

In my last post, I referred to the reaction of the bond market to monetary policy. In this latest decision, Powell was very clear that term premium, the additional return that investors demand based on perceived risks, is driving up long-term rates. He insisted these yields are not going up because of inflation expectations or policy expectations. Thus, Powell is instead blaming unsustainable deficits and expectations for future massive bond issuance. However, the jury is still out. The bond market responded to the last two cuts with swift increases in long-term yields. This time, with no rate cut, the bond yields remained well-behaved.

The reaction to tariffs will be interesting. Yields could decrease because of anticipated economic weakness. Yields could increase because of anticipated inflationary pressures. Of course, sitting in the middle is stagflation. Either way, my trading strategy to fade rallies in iShares 20+ Year Treasury Bond ETF (TLT) does not look nearly as good as before!

The iShares 20+ Year Treasury Bond ETF (TLT) held mostly steady for the week right under resistance from the bottom of the previous trading range.

The Canadian Dollar In A Storm

There is a lot to say about the U.S. dollar and the current volatility in currency markets. The Canadian dollar (FXC) is particularly interesting because I thought by now USD/CAD would have broken through major resistance from a major double top. Instead, USD/CAD has churned in a wide trading range. After wild trading on Thursday and Friday tariff headlines, USD/CAD settled just above the top of that range. I decided to take profits and just wait to get back in on a fresh breakout and clear trend.

Be careful out there!

Full disclosure: long TLT puts

The post A Fed Calm Before A Market Storm? appeared first on Inflation Watch.

The Carry Trade

Simply put, the carry trade is the act of borrowing in a currency with low interest rates and using those funds to buy assets with higher rates or anticipated returns (like stocks). The Japanese yen became an “easy” carry trade for big investors because the Japanese yen (FXY) had near zero interest rates. Once the Fed started hiking rates, traders could earn increasing returns by borrowing in yen and buying U.S. bonds. After equity markets bottomed in October, 2023, traders could earn increasing return borrowing yen to buy stocks (at least one analyst thinks the carry trade has been in effect since the rebound from the Great Financial Crisis!). Crypto currencies are even acting like they have been caught up in this massive delveraging. At the time of writing Bitcoin (BTC/USD) is down around 24% in just 8 days and looks like it could soon reverse all its gains since the SEC approved Bitcoin spot ETFs.

The strength in the yen and the presumed unwind of the carry trade has been breathtaking over the last two weeks. The Australian dollar versus the Japanese yen (AUD/JPY) has fallen around 17% in the three weeks since its last peak. AUD/JPY now sits at levels last seen in early June, 2023. AUD/JPY has long been my favorite currency market indicator of sentiment in the stock market. However, the current decline happened so rapidly, that I had no time to adjust my mind to appreciating that AUD/JPY suddenly mattered again in a significant way. After all, the Bank of Japan “only” hiked its target rate from 0% to 0.25%. The hawkish tone of the BoJ on normalizing policy must have traders scrambling to get completely out of the way of future rate hikes.

So what now?

Financial markets are essentially in panic mode. It is near impossible for the stampeding herds to see the other side of this major market disruption. As a contrarian of extremes in financial markets, I am compelled to lean the other way even though market breadth in the stock market still needs to fall significantly to hit oversold levels. Thus, I cannot buy as aggressively as I normally would…”nibbling” is my modus operandi for now (I am also re-accumulating cryptocurrency positions like BTC/USD).

In currency markets, I slipped on my well-crafted trading strategy on the Japanese yen. I gave up on the short GBP/JPY too early, and got overly confident in what looked like the obligatory rebound for USD/JPY side. So, in recent days, I have raced to keep up with new short GBP/JPY positions and have been simply astounded by how fast these positions hit profit targets. This clearing in turn forces me to reload at lower prices as the Japanese yen keeps racing away. Last week, I even dabbled in shares and call options in Invesco CurrencyShares® Japanese Yen Trust ETF (FXY). At SOME point, this non-stop slide in yen currency pairs will end and give way to a (potentially) abrupt and vicious countertrend relief rally. That time will offer a brief opportunity to bail on short yen positions and then step aside to catch a few breaths!

Be careful out there!

Full disclosure: long AUD/JPY, long USD/JPY, short GBP/JPY, long BTC/USD

The post The Carry Trade Sweeps the Sahm Rule Aside appeared first on Inflation Watch.