May 15th 2023

Hedge Funds Bet Against Rate Cuts Happening This Year

Last week I wrote that the regional banks were to blame for the lack of a rally after various reports showed that the economic data is heading in the right direction.

Of course, there’s always more to the story.

Bloomberg reported that macro hedge funds are shorting options against interest rate cuts happening this year. Even though the market wants to see rate cuts and many people are talking about it happening, we are seeing macro hedge funds positioning themselves for rate cuts to happen in 2024.

Since the rate cuts began, we saw a quick-ish deceleration in inflation, but that is now slowing. The hedge funds are betting that the Fed will need to keep rates higher for longer (where have we heard that before?) and the rate cuts won’t be coming later this year after all.

What are hedge funds thinking?

A recession is caused by a slowing economy and a decline in demand for goods and services. This puts pressure on the discretionary spending industry. But China continues to boost the availability of cheap goods.

The job market is holding strong and people are still spending. Look at the chart of the Consumer Discretionary sector in 2023. That’s not showing a slowdown in spending.

Energy prices are still in turmoil from the war in Ukraine.

These items aren’t ‘transitory’ – to quote a line from the Fed.

The hedge funds are making options bets that these items will continue to have long-term effects on how supply chains work, and therefore inflation won’t be able to settle down to the Fed’s goals.

In other words, interest rates will need to remain elevated and rate cuts aren’t happening any time soon.

Yes, the market cheered a 4.9% Consumer Price Index (CPI) number on Wednesday because it was supposed to be 5%, but maybe the hedge funds are right and that’s why there was no follow-through the rest of the week.

The S&P 500 continues to trade in a tight trading range as volatility continues to drop. This tends to lead to an explosive move to one side or another. The question is – in which direction is it going to pop?

Here’s the SPY on a weekly chart. Trade with the trend, but be cautious as we are at the high end of the existing trend range.

Let’s take a look at what you need to know about the week ahead.

Here are the items to watch out for this week:

Tuesday – Core Retail Sales – 8:30 am EST – Automobiles account for roughly 20% of retail sales and is a volatile market, so Core Retail Sales removes that segment. The previous report showed sales dropped 1% month-over-month. This month the market is expecting a 0.8% increase. Look at Consumer Discretionary and the stocks within that sector if retail sales show strong numbers.

Thursday – Unemployment Claims – 8:30 am EST – Look for a slight pullback from last week’s numbers of 264k. This week the market is expecting 251k. That would bring the 4-week moving average to around 246k, which is still showing a healthy job market.

Thursday – Philadelphia Manufacturing Index – 8:30 am EST – A number above 0 indicates improving conditions, while anything less than 0 is showing contraction. Last month’s reading was -31.3, which was an increase from the previous month’s reading of -23.2. That shows manufacturing is contracting at an increased rate. The forecast for this month’s report is -19.4, which would show that while still in a contraction phase, manufacturing could be showing signs of improvement.

Friday – Fed Char Powell Speaks – 11:00 am EST – The Fed Chairman is participating in a monetary policy panel discussion and while it may not have the same weight as an FOMC meeting minutes reveal, you just never know what he might say and how the markets will react. It’s at least good to be aware of this discussion.

Happy trading this week.

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Jeff Wood

Editor, Filthy Rich Dirt Poor
Coach, Options Testing Lab

Any trade or trade idea discussed is for educational purposes only.  They will not be tracked as an official trade recommendation.