We can try to predict when the Federal Reserve may pivot to a less hawkish stance by using charts. Below are some helpful charts.
1. Money Supply
The chart shown above is a monthly chart of the U.S. money supply (M2SL).
The white line shows the money supply over time. Below the white line is a stepped moving average (9 period), which I consider the 'steps of a debt-based economy'.
In order for our debt-based economy to persist, the money supply must continue moving up these steps endlessly. For reasons beyond the scope of this post, if the money supply falls much below this level a financial crisis is likely to ensue due to credit and liquidity issues.
Below are some examples in which money supply came down to the stepped moving average before climbing higher.
Not even during periods of higher inflation did the Federal Reserve let the money supply fall below this level. Therefore, the closer the money supply comes to this stepped-moving average, the more likely we are to see the Fed pivot to a less hawkish stance. Since money supply is largely negatively correlated to the value of all assets priced in U.S. dollar, reaching this level may also be somewhat of a buy signal for these assets (e.g. stocks, Bitcoin). Indeed, the fact that money supply always goes up is a large part of the reason why the stock market always goes up, too.
Whereas if inflation becomes so severe that it forces the Fed to take the unprecedented step of dropping the money supply below this critical level, then a financial crisis will likely ensue. Indeed, under the surface a crisis is already brewing. (You can see my posts linked below for more charts on this).
2. Eurodollar Futures
It is generally accepted that the Eurodollar Futures chart is one of the best leading indicators for the Fed Funds Rate. (Don't know what Eurodollar Futures are? See the link at the bottom of this post.)
Therefore, when Eurodollar Futures plateau or begin dropping, we can expect a Fed pivot. However, this assumes that the Fed Funds rate has actually reached the terminal rate implied by Eurodollar Futures, which has not yet happen because the Fed is so far behind the curve with hiking.
Keep an eye on how markets react to quad witching on September 16th, the time at which stock-index futures, options on stock-index futures, single-stock options and index options simultaneously expire. This period has been known to generate significant volatility. See the bottom of this post for more information about quad witching if you're unfamiliar with it.
3. Yield Curve Inversion
Usually around the time or shortly after the yield curve inverts, the Fed pivots to a less hawkish stance. Right now the 10-year and 2-year yields on treasuries are inverted. Below is a chart of the US10Y/US02Y ratio.
In the below chart, I marked the points at which the Fed pivoted in the past (pivots were measured by marking the last date the Fed raised rates). The values that you see labeled on the bottom right are the values of the US10Y/US02Y ratio at the time the Fed pivoted in past hiking cycles.
In the chart below, I zoomed into the current time. As you can see, the US10Y/US02Y ratio is currently below all the levels at which the Fed previously pivoted. Green is the highest ratio at which the Fed pivoted and red is the lowest ratio at which the Fed pivoted.
The chart above shows that we are in uncharted territory in the scope of yield curve inversion that the Fed has created. The fact that the Fed has forced the yield curve invert to this extreme degree and has still not pivoted is likely reflective of one or both of the following hypotheses:
(1) The Fed started hiking rates too late.
(2) The factors of inflation from the demand side and/or supply side are worse than we experienced in the past (since at least 1988 -- the period covered by the data in the chart).
Nonetheless, the Fed must pivot soon or risk causing a financial crisis. My hypothesis is that an inverted yield curve can have the effect, among others, of destroying money. Since some banks borrow at short term rates and lend at long term rates, an inverted yield curve makes this less profitable or even unprofitable. Therefore some banks will lend less. Since bank lending creates the most money, an inverted yield curve can decrease the money supply substantially. The Fed cannot let this monetary phenomenon continue for long without causing significant issues.
4. Inflation
Of course the biggest consideration for the Fed is the rate of inflation. The next CPI report is not scheduled to be released until the morning of September 13, 2022, but we can use chart analysis to, with a high degree of certainty, predict the rate of inflation.
The above chart is a chart of the price of gold (GOLD) multiplied by the Commodity Index Tracking Fund (DBC). This chart allows us to extrapolate both the supply and demand side of inflation to a high degree of certainty. It is a statistically valid leading indicator for the inflation rate. You can see how drastically it has fallen recently. You can also see how closely it matches the chart of the inflation rate on a lagging basis.
For those interested in the statistics GOLD*DBC correlates to USIRYY as follows: r = 0.904, r-squared = 0.8844, p = 0
In the chart above I provide an even better correlation to the rate of inflation. In this chart I provide the total securities sold by the Federal Reserve as part of their overnight reverse repurchase facility, I then attempted to improve the correlation values by adjusting the value by using the price of gold as a multiplier. Although this may sound complex to those who are not familiar with the repo facility, in short it just represents the amount of dollars that the Fed is pulling out of the banking system. To diminish the effect of any non-inflationary factors that would cause the Fed to do this, I adjusted the value using the price of gold.
Recently, the Fed has been pulling less dollars out of the system and on some days it has actually been putting more dollars back into the system. The Fed would not be putting more dollars into the system if inflation were still spiraling out of control. While anything can happen in the future, and additional inflationary shocks can occur, this equation gives us a tool to predict the rate of inflation before the CPI report is published.
For those interested in the statistics, GOLD*RRPONTTLD correlates to USIRYY as follows: r = 0.954, r-squared = 0.94, p = 0
In the chart above, I've adjusted the values to match the inflation numbers as best as I could (I simply used a divisor that equates the peak values in both charts). It is far from perfect and it is definitely not something that you should use to trade on. The number that is actually reported by the government could be way different. The best that we, as traders, can ever do is use charts to try to predict what may happen, which is what I've done here.
More information about Eurodollar Futures: www.investopedia.com...rodollar-futures.asp
More information about Quad Witching: www.investopedia.com...uadruplewitching.asp
1. Money Supply
The chart shown above is a monthly chart of the U.S. money supply (M2SL).
The white line shows the money supply over time. Below the white line is a stepped moving average (9 period), which I consider the 'steps of a debt-based economy'.
In order for our debt-based economy to persist, the money supply must continue moving up these steps endlessly. For reasons beyond the scope of this post, if the money supply falls much below this level a financial crisis is likely to ensue due to credit and liquidity issues.
Below are some examples in which money supply came down to the stepped moving average before climbing higher.
Not even during periods of higher inflation did the Federal Reserve let the money supply fall below this level. Therefore, the closer the money supply comes to this stepped-moving average, the more likely we are to see the Fed pivot to a less hawkish stance. Since money supply is largely negatively correlated to the value of all assets priced in U.S. dollar, reaching this level may also be somewhat of a buy signal for these assets (e.g. stocks, Bitcoin). Indeed, the fact that money supply always goes up is a large part of the reason why the stock market always goes up, too.
Whereas if inflation becomes so severe that it forces the Fed to take the unprecedented step of dropping the money supply below this critical level, then a financial crisis will likely ensue. Indeed, under the surface a crisis is already brewing. (You can see my posts linked below for more charts on this).
2. Eurodollar Futures
It is generally accepted that the Eurodollar Futures chart is one of the best leading indicators for the Fed Funds Rate. (Don't know what Eurodollar Futures are? See the link at the bottom of this post.)
Therefore, when Eurodollar Futures plateau or begin dropping, we can expect a Fed pivot. However, this assumes that the Fed Funds rate has actually reached the terminal rate implied by Eurodollar Futures, which has not yet happen because the Fed is so far behind the curve with hiking.
Keep an eye on how markets react to quad witching on September 16th, the time at which stock-index futures, options on stock-index futures, single-stock options and index options simultaneously expire. This period has been known to generate significant volatility. See the bottom of this post for more information about quad witching if you're unfamiliar with it.
3. Yield Curve Inversion
Usually around the time or shortly after the yield curve inverts, the Fed pivots to a less hawkish stance. Right now the 10-year and 2-year yields on treasuries are inverted. Below is a chart of the US10Y/US02Y ratio.
In the below chart, I marked the points at which the Fed pivoted in the past (pivots were measured by marking the last date the Fed raised rates). The values that you see labeled on the bottom right are the values of the US10Y/US02Y ratio at the time the Fed pivoted in past hiking cycles.
In the chart below, I zoomed into the current time. As you can see, the US10Y/US02Y ratio is currently below all the levels at which the Fed previously pivoted. Green is the highest ratio at which the Fed pivoted and red is the lowest ratio at which the Fed pivoted.
The chart above shows that we are in uncharted territory in the scope of yield curve inversion that the Fed has created. The fact that the Fed has forced the yield curve invert to this extreme degree and has still not pivoted is likely reflective of one or both of the following hypotheses:
(1) The Fed started hiking rates too late.
(2) The factors of inflation from the demand side and/or supply side are worse than we experienced in the past (since at least 1988 -- the period covered by the data in the chart).
Nonetheless, the Fed must pivot soon or risk causing a financial crisis. My hypothesis is that an inverted yield curve can have the effect, among others, of destroying money. Since some banks borrow at short term rates and lend at long term rates, an inverted yield curve makes this less profitable or even unprofitable. Therefore some banks will lend less. Since bank lending creates the most money, an inverted yield curve can decrease the money supply substantially. The Fed cannot let this monetary phenomenon continue for long without causing significant issues.
4. Inflation
Of course the biggest consideration for the Fed is the rate of inflation. The next CPI report is not scheduled to be released until the morning of September 13, 2022, but we can use chart analysis to, with a high degree of certainty, predict the rate of inflation.
The above chart is a chart of the price of gold (GOLD) multiplied by the Commodity Index Tracking Fund (DBC). This chart allows us to extrapolate both the supply and demand side of inflation to a high degree of certainty. It is a statistically valid leading indicator for the inflation rate. You can see how drastically it has fallen recently. You can also see how closely it matches the chart of the inflation rate on a lagging basis.
For those interested in the statistics GOLD*DBC correlates to USIRYY as follows: r = 0.904, r-squared = 0.8844, p = 0
In the chart above I provide an even better correlation to the rate of inflation. In this chart I provide the total securities sold by the Federal Reserve as part of their overnight reverse repurchase facility, I then attempted to improve the correlation values by adjusting the value by using the price of gold as a multiplier. Although this may sound complex to those who are not familiar with the repo facility, in short it just represents the amount of dollars that the Fed is pulling out of the banking system. To diminish the effect of any non-inflationary factors that would cause the Fed to do this, I adjusted the value using the price of gold.
Recently, the Fed has been pulling less dollars out of the system and on some days it has actually been putting more dollars back into the system. The Fed would not be putting more dollars into the system if inflation were still spiraling out of control. While anything can happen in the future, and additional inflationary shocks can occur, this equation gives us a tool to predict the rate of inflation before the CPI report is published.
For those interested in the statistics, GOLD*RRPONTTLD correlates to USIRYY as follows: r = 0.954, r-squared = 0.94, p = 0
In the chart above, I've adjusted the values to match the inflation numbers as best as I could (I simply used a divisor that equates the peak values in both charts). It is far from perfect and it is definitely not something that you should use to trade on. The number that is actually reported by the government could be way different. The best that we, as traders, can ever do is use charts to try to predict what may happen, which is what I've done here.
More information about Eurodollar Futures: www.investopedia.com...rodollar-futures.asp
More information about Quad Witching: www.investopedia.com...uadruplewitching.asp
Comment:
The August inflation report came in at 8.3% as predicted above.
Comment:
One thing that's concerning is that both charts that I use to predict the inflation rate appear to potentially be bull flagging. How insane will things get if inflation continues to spiral? Leave comments below with thoughts. Curious about what others are seeing in terms of inflation leading indicators.
Comment:
On the last trading day of 2022, the overnight reverse repurchase agreements sold by the Federal Reserve exploded to a new all-time high.
The reverse repo facility took in $2.554 trillion in cash from money market funds and other eligible financial firms, breaking the prior all-time high set on Sept. 30th, which totaled $2.426 trillion.
While it's not necessarily surprising that a spike occurred at the end of December since firms often look to park the most amount of cash at the central bank right at the end of each month, the overall uptrend in December is noteworthy.
The uptrend is noteworthy because one would expect that before the Fed pivots away from monetary tightening, it will begin taking in less cash via its reverse repo facility. This uptrend could suggest that, even with all the historically rapid increases in the Fed Funds Rate in 2022, the Fed may still not even be near an actual pivot back to monetary easing.
Yet, under the surface, cracks are beginning to appear. The amount of continuing unemployment claims are beginning to rise, home sales continue to decline, and liquidity issues in the speculative fringes of the market are spreading.
In 2023, each of these issues is likely to become front and center, as we head into a perfect storm of economic headwinds that will likely result in severe stagflation.
The reverse repo facility took in $2.554 trillion in cash from money market funds and other eligible financial firms, breaking the prior all-time high set on Sept. 30th, which totaled $2.426 trillion.
While it's not necessarily surprising that a spike occurred at the end of December since firms often look to park the most amount of cash at the central bank right at the end of each month, the overall uptrend in December is noteworthy.
The uptrend is noteworthy because one would expect that before the Fed pivots away from monetary tightening, it will begin taking in less cash via its reverse repo facility. This uptrend could suggest that, even with all the historically rapid increases in the Fed Funds Rate in 2022, the Fed may still not even be near an actual pivot back to monetary easing.
Yet, under the surface, cracks are beginning to appear. The amount of continuing unemployment claims are beginning to rise, home sales continue to decline, and liquidity issues in the speculative fringes of the market are spreading.
In 2023, each of these issues is likely to become front and center, as we head into a perfect storm of economic headwinds that will likely result in severe stagflation.
Comment:
The Fed must pivot but cannot pivot. It must pivot to avoid a severe recession and liquidity crises, but it cannot pivot because commodity prices are bull flagging on higher timeframe charts. This stagflationary paradox is a central bank's worst nightmare because it is powerless to avoid economic decline. Thus, we are left with only one conclusion: the busts that characterize the cycle of boom and bust may be delayed, but cannot be avoided, by central bank monetary policy.
Comment:
This is a smoothened 9-period moving average of the U.S. money supply (M2). Looking back to 1960 it has never declined. Beginning in late 2022 it started to decline for the first time on record.
This chart is a warning that liquidity issues may come in the future.
This chart is a warning that liquidity issues may come in the future.
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