The Fed’s Hidden Rate Cut By Michael Salvatore, Editor, TradeSmith Daily In This Digest: - The Fed pulled one lever in the wrong direction…
- All told, the economy is looking fine…
- DOGE’s worst-case immediate impact on unemployment…
- This trader is cleaning up…
- The biggest expansion to TradeSmith ever…
The only thing worth mentioning about Fed Day… If you felt any Fed talk was suspiciously missing from Wednesday’s Daily, here’s why. TradeSmith Daily publishes on a one-day lag. And I’m not in the habit of commenting on events until they happen. Speculating on Fed meetings especially isn’t worth much… because surprises are rare. As the market expected, the Fed held rates steady and reinforced what anyone paying attention already knows: the economy is “strong overall” and resilient to the short-term disruptions of the last month. More on that in a moment. First, there was one small surprise in this week’s Fed decision. Jerome Powell pulled one of his levers in arguably the wrong direction. The Core Price Consumption Expenditures (PCE) is not terribly high (up 2.8% in February, against an average annual rate of 3.4% since 1978), but sticky regardless (pandemic era aside, it’s rising at the fastest pace since 1996). Yet the Fed has made the decision to slow the pace of its balance-sheet reduction yet again. This was a rate cut that’s not a rate cut. As in, it provides liquidity to the financial system and does nothing to slow inflation. Now, lately I’ve been talking a lot about M2 and its relationship to the Core CPI. Namely, how M2 creation has outpaced the rate of inflation for the first time since 1995. But M2 has other relationships… Like with the Fed’s balance sheet… When the Fed buys assets (usually Treasurys and mortgage-backed securities) with newly created money, that’s called Quantitative Easing (QE). It’s trying to raise the prices of these assets and lower their yields. The balance sheet rises when there are more assets than liabilities. There’s more liquidity in the economy, which generally helps asset prices while suppressing bond yields. Quantitative Tightening (QT) is when the Fed lets its Treasury holdings mature, and therefore “roll off” the balance sheet. When they do, that money comes back to the Fed and effectively goes “poof,” removing it from the financial system. It also stops artificially suppressing bond yields. In this long-run chart of the Fed’s balance sheet, we can see QT happening when the line goes down…and QE happening when the line goes up. Since 2008, the Fed’s balance sheet has run from $1 trillion to just under $7 trillion: 
The Fed started QE after the Great Financial Crisis in 2008 to try to support the economy. It then continued that QE for many years, before starting QT in 2018. Then 2020 happened, and the Fed did so much QE the balance sheet more than doubled in size. Starting in 2022, the Fed resumed QT, took a little break because of the 2023 banking crisis, and then got back to work shortly after. Now, the balance sheet is about where it was in mid-2020, still around $3 trillion higher than it was at the 2019 lows. But the Fed announced Wednesday that it intends to slow QT. It will let fewer of its Treasury assets mature and roll off the balance sheet. To be specific, it was previously rolling off a cap of $25 billion per month and will now do a fifth of that, $5 billion. So, the amount of QE-driven liquidity will retrace at a rate 20% of what it was before. The Fed has come just short of stopping QT altogether. And if you’re not happy with the inflation rate, you probably don’t want to do this. It means more money in the system, which can lead to more inflation. We’re not seeing QE yet, where the Fed starts to initiate new purchases. And we probably won’t until and unless there’s a significant crisis afoot. Regardless, you can see where I’m going with this. This is yet another sign that the trend of overall liquidity is up. And when liquidity rises, financial assets of all kinds – stocks, real estate, and especially riskier stuff like crypto – does very well. Inflation is also probably sticking around, though it’s not likely we’ll see a 2022-style spike without another big balance-sheet expansion. What’s this mean? It means it’s very difficult to argue the bull market is over. If anything, more liquidity means it’s just getting started and the recent volatility was indeed just a run-of-the-mill correction. That’s no guarantee, but I’m taking the bull side of the recent hiccup. Especially because the economy is solid… Last week, I had a lot of fun looking at the track record of the AAII Investor Sentiment survey and the Atlanta Fed’s GDPNow forecasts. Turns out they’re both kind of iffy. And we got two data points this week that show us there’s little need to worry about the economy as much as the Atlanta Fed is. For one, housing sales surprised to the upside, at 4.26 million against consensus expectations of 3.95 million. And for two, despite pearl-clutching over DOGE’s federal workforce cuts, the labor market is holding firm at an unemployment rate of 4.1% and only a slight miss in monthly payrolls (151,000 vs. 160,000). DOGE may do more damage in the future. Vivek Ramaswamy, originally the co-leader of DOGE, has long called for dropping the federal workforce to 25% of their then-current levels. That’s still the best number we have, so let’s play with that. A 75% reduction would take a workforce of about 3 million down to 750,000. As a percentage of the overall workforce, it would drop from 1.9% to 0.5%. Now, assuming none of those employees got new jobs, that would represent an increase in the unemployment rate from 4.1% to 5.5%, the highest rate since 2021 but still not all that obscenely high. Will those employees get new jobs? Probably. And will this take a long time? Also probably. So, I don’t expect a huge, immediate, disruptive jump here. And to be clear, federal workforce reductions do have knock-on effects. More non-federal employees could be out of work as a result. That means, despite labor being solid right now and the impact of DOGE maybe not as much as feared, it’s still a key thing to watch in the months ahead. Finally, the Fed itself forecasted slower GDP, higher unemployment, and higher inflation, but in truly cursed fashion Jerome Powell brought out the word “transitory” to describe the effects of President Trump’s tariffs. Anyone in the market circa 2021 knows the meaning of the word “transitory” has become a bit of a meme, with the last call that inflation would be “transitory” not exactly bearing out. But as Powell himself said, these are unknowns. Labor and housing are solid. And while consumer confidence has made a huge dip, please note that doesn’t have a good long-run correlation with spending, as you can see with the wide variance between blue and green bars in this graph: 
If you’re a long-term investor, you want to lean bullish here. But if you’re more of a trader, there’s something you have to see… Longtime readers of TradeSmith Daily will be familiar with the name Jonathan Rose. Jonathan’s a master of volatility, order flow, and correlations between different asset classes. Basically, everything you need to know to be an excellent short-term trader. And while many investors are sitting and waiting for this correction to play out, Jonathan and his subscribers have been lunging into the fray and escaping with profit after profit. Last week, Jonathan closed out a 78% gain on small-cap fitness company Xponential Fitness (XPOF), leading one member to say they made $33,000 on that one trade. The week before, Jonathan closed out an earnings play on Groupon (GPRN), using an options strangle to deliver a 302% gain on the call side and 74% overall. And on that same week, Jonathan delivered gains of 55% on URBN puts and 67% on GAP calls as part of his Divergence strategy. In short, the guy has been cleaning up amid all this volatility. In the Divergence strategy I just mentioned, he currently holds a 75% win rate and an average winning trade of 31.6%, over an average hold time of about 39 days. And in his earnings-focused strategy, Jonathan holds a 66.7% win rate with an average gain of 48.8%. Access to these programs is closed, for the time being. But to get the first word on when they open, along with a first-rate education from Jonathan himself, live on video, click this link to join his free daily livestream. There, Jonathan shares the secrets he learned working as a pit trader at the Chicago Board Options Exchange, and how he applies them during times of outsized volatility. TradeSmith is about to get a whole lot bigger… Speaking of trading volatility, there’s been all kinds of bullish stock signals lighting up in TradeSmith – especially from our newest tools. Like the Snapback Trades in Ideas by TradeSmith… Seasonal Edge in Trade Cycles… And the RSI Precision and Bollinger Bands Strategies that are exclusively for our Platinum Partners. Our 20th anniversary of TradeSmith has certainly been a year to remember already – and we’re capping that up with even more changes. And while we’re about to unleash a number of small changes, including major upgrades to Predictive Alpha, Options360, and our Billionaire Portfolios… The real story is in the biggest expansion to the TradeSmith lineup in many years. We’re joining forces with two new brands that boast unique talents to contribute to our community. Keith is getting ready to announce all the details next week… when he’ll fill you in on some of the biggest acquisitions in TradeSmith’s history. Keith is also taking us way “outside the box” in our 20th year regarding how you currently subscribe to various TradeSmith products. Click here to automatically save your seat next Wednesday at what Keith’s calling his Big Reveal. It’s become controversial behind the scenes, to be frank, so I can’t wait to see what you think of it. To your health and wealth, 
Michael Salvatore
Editor, TradeSmith Daily | 
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