Smart Bet: Markets Pricing in a Fed Policy Error

Hey There Income Hunters, 

 

As usual, Jerome “J-Pow” Powell is day late and a few rate hikes short.

 

Powell brought his usual hawkish talk to the table on Friday, reiterating the Fed’s move to taper $20 billion from the QE policy that continues to add to $120 billion per month to the banking system.

 

Not a great time to spook the economy by announcing removal of stimulus just as consumer confidence plunged below lows reached during pandemic.

 

In fact, consumer confidence is heading towards the lows of the 2008 financial crisis!

 

Now the Fed wants to start tightening!? Have you ever seen such incompetence?

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No big surprise here … Here is the consumer’s assessment of the US government’s policy …

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Today I will lay out the Fed’s policy and what to expect from the market this week …

 

Coulda, Woulda, Shoulda

 

Quick question … if the Fed really wanted to normalize rates without bursting the everything bubble wouldn’t the smart move have been to begin the taper process in January when consumer confidence was high, and the 10-year yield was below 1%?

 

This is where the Fed is so clueless … 

 

They should deflate asset prices when the financial system is strong and manage an orderly decline, which would be smaller and less dangerous than inflicting the most pain on Americans as possible.

 

Banks are required to stress test their activities against an economy in recession, why isn’t the Fed? 

 

If the Fed was forced to be accountable for it actions, maybe they wouldn’t have to BAIL OUT, the banks when the sh*t hits the fan.

 

What the Markets Are Telling Us …

 

The US, Japan and Euro inflation breakeven rates all made new highs on Friday …

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Inflation is already out of control.

 

After dropping when Powell first started talking about transitory inflation following the June and July Fed meetings, the market is now looking past the QE taper and shifting to higher inflation for longer.

 

Gold Is Pricing in a Fed Error and More Stimulus Ahead

 

Gold has always anticipated trends. Notice the physical gold chart below … 

 

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Beginning in June (first red circle) with the first Fed meeting that mentioned transitory inflation, gold traded off in anticipation.

 

Same reaction in July. However, in September gold put in its first higher low post-Fed. Then in October gold rallied on the day of the Fed meeting.

 

If gold is able to put in another higher low in the weeks heading into the taper, that would be a very bullish sign …

 

Buy gold stocks on a dip to $1750-$1760 or on a breakout above 1815.

 

Bond and Stock Volatilities are Going Their Separate Ways 

 

Bond volatility as measured by the Bloomberg MOVE index is approaching recent highs while the VIX (S&P vol) is nearing all-time lows.

 

This may also be a forward looking indicator, anticipating a Fed policy error and resumption of the reflation trade.

 

That would be confirmed if stocks breakout higher and the iShares 20 Plus Year Treasury Bond ETF (Ticker: TLT) resumes its downtrend …

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This week will be critical for stocks, as last Friday’s trade could turn out to be a false breakout higher. Friday also made a higher high and a lower low and settled lower on the day, which is also a bearish pattern.

 

So, if the S&P 500 is able to make a new high on higher volume that could be a sign of a melt up into year end.

 

Conversely, if the S&P starts sliding today, it may be a trade to jump on to see if we get a bit of an investor temper tantrum …

 

Bring it Home 

On Friday I purchased iShares Gold Trust ETF (Ticker: GLD) Nov. 19 169.5/168.5 put Spreads to hedge my GLD Nov. 19 166/167 call spreads.

 

I jumped on the opportunity to set up bearish spreads against the important resistance in Gold above $1,800.

 

It also gives me an opportunity for maximum gains on both spreads. Here is my potential on each: 

 

      • GLD 169.5/168.5 put spread – in at $.26 w/ max gain of $100 
      • GLD 166/167 call spread – in at %.23 w/ max gain of $100

 

Let’s chalk it up to the power of the vertical option spreads!

 

Plus, I always enter my safety-valve stop loss order to limit my capital at risk to 25% of the margin debit demanded on the trade …

That increases my return on capital at risk to 

 

      • GLD 169.5/168.5 ($.19 risk to $1 reward) or 525% return
      • GLD 166/167 ($.16 risk to $1 reward) or 625% return 

 

Optimal risk management makes a huge difference in your returns!

 

Live and Trade With Passion My Friends,

Griff

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