Is Powell Turning Dovish?

Good Afternoon,

It was a BIG week for Wall Street. Investors breathed a sigh of relief after the Fed hiked interest rates by 75 bps, nobody can agree on whether we're in a recession or not, and everybody wants to know what JPow will do next.

This week, we’re diving into all things Federal Reserve and what the Q2 GDP data means for the economy.

In the News

Very interesting week. Kalshi markets think the job market will stay strong, the Fed will take a dovish stance come September, and the U.S. economy may show signs of growth come Q3.

Market forecasts from 07/28.

Where Do We Go From Here?

Despite pump faking investors with the chance of a 100 bps rate hike earlier this month, the Fed opted to hike rates by 75 bps again. Investors loved it.

The Fed’s decision to hike interest rates by 75 basis points on Wednesday surprised... absolutely nobody. At market close, Kalshi markets predicted that the likelihood of the rate hike being at least 75 basis points was 97%. This consensus was shared at the Fed, which made its first unanimous decision since 2005.

This is not to say that the lead-up to this decision was without uncertainty. Earlier this month, following the release of a searing hot June inflation report, a rate hike of a whole point was on the table.

Just two weeks ago, Kalshi markets predicted a 69% chance that the July rate hike would be 100 bps or more. This was fueled by statements like those made by Atlanta Fed President Raphael Bostic, who asserted in July that "everything is in play".

Although many investors were rattled by a same sized rate hike in June, markets soared in response to this one. All three major indexes notched significant gains, with the Nasdaq surging over 4%. This market response was investors breathing a large sigh of relief that, after a short-lived scare of a possible 100 bps rate hike, the Fed was taking a more dovish stance.

The comments made by JPow after the announcement didn't hurt either. Highlighting strength and robustness in the labor market, Powell pushed back against recession fears. Powell claimed that he does not believe the U.S. is currently in a recession as "there are just too many areas of the economy that are performing too well."

The bigger question is what will the Federal Reserve do going forward?

Forecasting Dashboard from Kalshi

Powell stated that the full effects of these past rate hikes have likely not been felt by the economy, paving the path for rate hikes of a smaller magnitude going forward. However, Powell also went on to say that "another unusually large increase [of 75 bps] could be appropriate at our next meeting" and that he would no longer provide forward guidance as he did in Q4 of 2020.

But even if JPow will no longer provide forward guidance, Kalshi's markets can. Kalshi's interest rate markets are forecasting a 32% chance that the Fed will hike rates by 75 bps or more in the upcoming September meeting and a 91% chance the hike will be 50 bps or more.

Only time will tell for sure.

Recession? Never Heard Of Her

Everybody wants to know if we're in a recession - wait what's a recession again?

The data for U.S. Q2 GDP came out Thursday, and it was not pretty.

The Bureau of Economic Analysis reported that the U.S. economy contracted by 0.9% in the second quarter, which was significantly worse than the Dow Jones estimate for a gain of 0.3%. This report followed an already bleak 1.6% decline in GDP in the preceding quarter.

Similar to the Fed's decision to hike rates 75 bps, the news of another decline in quarterly GDP did not come as a huge surprise to investors. At market close the day before, Kalshi markets predicted that the probability of Q2 U.S. GDP being positive was just 36%.

Two consecutive quarters of negative GDP growth is the conventional definition for a recession, but many within the White House are pushing back.

Last week, the Biden administration released a document stating that two consecutive quarters of negative GDP growth is "neither the official definition nor the way economists evaluate the state of the business cycle." Treasury secretary Janet Yellen said in a recent interview that "even if the GDP number is negative, we are not in a recession now."

With just three months to go before midterm elections kick into full swing, many Republicans have accused the Biden administration of redefining "recession" for political purposes. Democrats have referenced the strong job market as a justification for why the U.S. is not in a recession, while also noting that the official determination of whether the United States is in a recession is up to the National Bureau of Economic Research (NBER).

Whatever definition you subscribe to, everyone can agree that the economy is not in great shape right now.

However, Kalshi's U.S. GDP markets are showing a 47% chance that the U.S. Q3 GDP will be greater than 1%, so hopefully good news is on the horizon.

Lit's Pick

With all of the recent rate hike talk, we think Powell will turn dovish in September. We're taking the "No" on a 75+ bps hike in September for $0.68.

That's all for today, have a great weekend 🤝

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