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Today’s very special guest piece comes from Dan at GTC Traders. Please enjoy this wonderful piece, either today or this weekend with a cup of coffee. Cheers
Inflation Remains High and the Stock Market Rallies?
Non-Prediction
As we have mentioned before, I've been trading for nearly 30 years now and trade as the Senior Partner in a Private Prop Firm. But GTC Traders itself, is a separate entity entirely, built to help new and aspiring traders. I say that, to say this: What we do at GTC Traders, without violating any NDA's the Partners have agreed to (including myself)? Is that we pretty much just copy our thoughts from that Private Entity, over to GTC Traders.
This allows us to assist new and aspiring traders, with something that is 'real'. Substantive. Not advice. But it allows them to have a 'look over our shoulder' so to speak; and evaluate our track record for themselves, and see 'our thoughts'.
And something that we never do in our private firm, and therefore you will not see at GTC Traders?
Is try to predict either individual economic releases, or the market in general in the distant future. Our quantitative processes, and our discretionary trading is much more built upon “going with the flow of the market' and trying to understand where we are 'right now'.
We don't predict. In fact, when we look at the science and mathematics of Complexity Mechanics? We believe that 'true prediction' is actually impossible.
But that's a topic for another time.
Regardless, while we do not predict what's going to happen 9 months in the future?
All of us … try to make sense of the market for where we are at right now. The mathematicians among us would refer to this as 'understanding initial conditions'. Ok, so what does that mean for the non-mathematicians among us? In simple language?
Where are we at 'right now'?
Forget predictions for something a year off in the future. All of us argue back and forth about what is happening right now. Or … again … as the mathematicians say “Initial Conditions”. We can't even agree on what is happening right now, so why should we be worried about a prediction 9 months from now? We're trying to make sense of the environment we are in … 'in the here and now'.
And speaking of the here and now? As I perused the social media streams I saw a lot of confusion among many traders regarding the rally in Equities. Both new and veteran traders alike ...
“Wait? How can we have continuing inflation? And we rally to all-time highs?”
“Is this all built upon rate cuts?”
“Interest Rate Markets are moving to cheaper yields?”
“Are they trying to tell us that Inflation has come down?”
So, let's discuss that. Inflation. Interest Rates. The Stock Market rally. And where we feel we are at right now.
The 'Sticky' Inflation Print and Confusion
We have made no secret about the fact, that we are within group of folks that believe we remain in an Inflationary environment that is going to be exceedingly difficult to bring to heel. There are a number of reasons for that, that I will not take the time to get into here. We're just trying to discuss where we think we are at, at the moment.
Simply put, we're in the “Inflationary is too High” camp. And we remain in the camp that Inflation will remain, and we will higher interest rates, for longer, or the “Higher for Longer” group of folks.. There may be one rate cut here and there of 25 BPS; as there was in the mid 1990's (You know about those right?) But overall, like the 1990's … we believe that Interest Rates have to remain high. Yes, the acceleration of Inflation has slowed. And with that disinflation of the Inflation rate slowing down (not deflation) the Equities market began to rally.
But Inflation is still too high. Core Inflation (which is what the Fed primarily pays attention to) was still 0.3% Month over Month. The Core Inflation rate is 3.6% Year over Year.
Here's a view of 'sticky' inflation that spans my entire career as a trader since the mid 1990's nearly 30 years ago …
What do we mean by 'Sticky' Inflation? It's calculated “from a subset of goods and services in the CPI that change price relatively infrequently”. Thus, the thought is … it gives you a more 'consistent' view of Inflation, with less volatility in month over month numbers.
And as you can see? Inflation remains high.
And we believe that the Fed does not want to repeat the mistake they made in 1976. Believe that the work of fighting inflation from 1972 to 1976 was over; only for Inflation to come roaring back, worse than it did before …
This is why the Fed is so concerned about not cutting too soon. They don't want to repeat that mistake.
And if that is their thinking? We would agree.
Interest Rates
Well, what about interest rates?
Haven't we just witnessed price rally across the curves, indicating cheaper yields and that the Fed must cut?
Well, not so fast.
Contrary to popular opinion? The Interest Rate markets do get it wrong from time to time, and they do get ahead of themselves.
We all know Yield Curve's are inverted, and have been inverted for some time.
Thus, we all know that the Interest Rate markets keep asking themselves the question:
“When will the Fed cut?”
We personally don't think they should. But that's a discussion for another time.
We can see then that the markets are particularly interested in short-term interest rates, or the STIRs markets. Higher rates dominate from the Overnight rate, to 52 week bills. Therefore, we have been paying attention to the SOFR or SR3 90 Day Secured Interest Rate Futures markets. Particularly, the June 2025 SR3 market.
Remember the rally in price in Interest Rates to lower yields from November 2023 to January of 2024, on the hopes of a rate cut? And what happened?
The markets … were wrong.
There were no rate cuts, and interest rate markets had to reset to that outlook for the first half of 2024, by dropping to lower prices and higher yields.
So simply because the interest rate markets decide to drop to lower yields today … does not convince us that 'Inflation has been squashed' and a rate cut is on the way.
Immediate outright interest rates markets have gotten it wrong before. And they can be wrong again. But will yields drop? Why not? They did from November 2023 to January of 2024. Honestly? I would not be surprised to see the SR3 June 2025 (SR3M2025) market drop to a yield of 4.2%, and thus rally to a price of 95.80. We are seeing this move in SR3, as we did from November of 2023 to January of 2024. The market getting ahead of itself.
Is there anything to substantiate that belief? I'm going to recommend a X / Twitter account.
If you're not following @discoverytrader of Discovery Trading Group (DTG)? I recommend them as a follow. Rob has been posting excellent information in regards the Forward EFFR OIS (Interest Rate Swaps) market. A market that measures a staggering 54 trillion in size.
And what does the 54 trillion dollar OIS market think of all of this? Well, as Rob posted earlier and you can see in this image?
Yeah, you're looking at that right.
Seven months into the future? The OIS sees no change in Interest Rates. In fact? It ticked a bit HIGHER in yields today. Not lower.
And this was the market, that pretty much nailed the November to January drop in yields as a farce.
Not surprising.
54.4 Trillion at work, tends to know a thing or two.
The Stock Market Rally
And yes, the Stock Market has begun to rally.
Stock Markets are notoriously histrionic.
They got ahead of themselves with a large rally in November of 2023 just on the hopes of a rate cut that never materialized
We see this rally in Equities in much the same way.
Will we be long and strong Equity histrionics?
You better believe it. As anyone can see, we are net-net long with our public positions. Although the markets were wrong about a rate cut from November of 2023 to January of 2024? It was correct to be long risk.
In the end, PnL is what matters.
Summary
So to summarize? We see today, much as we saw the rally that began in stocks in November of 2023. In the mere hope of a rate cut by the Fed, by an Inflation print that was honestly still too high, Indices began a ridiculous rally.
Ok?
Then, as ones can see? We will ride that wave. We are net-long risk, and have a positions benefiting from cheaper yields. Earlier today, we even removed our hedges on those positions. As Rob of Discovery Trading Group has highlighted, we are watching the OIS market, that is indicating again, there will be no rate cut and rates will remain in their current range.
It's not our job to convince the market that it's being irrational. We're just trying to understand the irrationality, to some extent; so we know the environment we are in.
But those are only our thoughts. Not yours …
Be safe and trade well ...