Why Tom Lee Expected a ‘Hawkish Cut’ from the Fed
Audio Brief
Show transcript
This episode covers the debate between Tom Lee and Barry Knapp on the Federal Reserve's upcoming rate decision and its market implications.
There are three key takeaways from this discussion: the Fed's dual policy tools, varied asset responses to Fed signals, and the importance of the yield curve for banks.
First, consider the Fed's dual policy tools. Beyond interest rate decisions, changes to its balance sheet strategy, like Quantitative Tightening or Easing, offer powerful signals about market liquidity. These separate policies significantly impact economic conditions.
Second, different assets respond uniquely to Fed signals. Equities typically focus on rate paths, but assets like Bitcoin are highly sensitive to overall liquidity. Barry Knapp highlights "duration tightening," where the Fed's balance sheet adjustments can pressure long-term yields. The end of Quantitative Tightening is seen as a major liquidity event for speculative assets like crypto.
Third, monitor the yield curve for insights into the banking sector. The Fed might cut short-term rates to steepen the curve, which benefits regional banks by improving their lending profitability. This strategy could present targeted investment opportunities in financials, even amidst broader economic uncertainty.
Understanding these nuances is critical for navigating the Federal Reserve's complex policy landscape.
Episode Overview
- Tom Lee of Fundstrat and Barry Knapp of Ironsides Macroeconomics debate the potential outcomes of the upcoming Federal Reserve rate decision, discussing whether the Fed will be hawkish or dovish.
- The conversation explores the nuanced difference between the Fed's interest rate policy and its balance sheet policy (quantitative tightening/easing), and how these separate tools impact different parts of the economy.
- The analysts break down how various asset classes, including equities, small caps, and cryptocurrencies like Bitcoin, are likely to react to different Fed signals regarding rates, liquidity, and forward guidance.
Key Concepts
- Hawkish Cut: The consensus expectation of a rate cut that is accompanied by cautious forward guidance, signaling that future cuts are uncertain or will be delayed.
- Dovish Cut: A rate cut combined with communication that suggests a clear path for further monetary easing in the near future.
- Quantitative Tightening (QT) vs. Quantitative Easing (QE): The discussion highlights that the end of QT (the Fed shrinking its balance sheet) is viewed by many, especially in the crypto space, as a form of QE (injecting liquidity).
- Duration Tightening (DT): A term used by Barry Knapp to describe the Fed's policy of reinvesting maturing mortgage-backed securities into short-term Treasury bills instead of longer-term notes. This action effectively reduces demand for long-term bonds, putting upward pressure on long-term yields.
- Policy Rate vs. Balance Sheet Policy: The idea that the Fed can use its two primary tools independently. For example, it could cut the policy rate to help steepen the yield curve for banks while simultaneously maintaining a restrictive balance sheet policy to manage long-term rates and inflation.
- Crypto & Macro Correlation: The speakers note that the price of Bitcoin is highly sensitive to both global liquidity conditions (driven by Fed policy) and the business cycle, as indicated by metrics like the ISM manufacturing index.
Quotes
- At 0:16 - "Precisely because our clients are expecting a hawkish cut... because that's the base case, then if that's what happens, of course, markets have already been bracing for that." - Tom Lee explains why stocks may remain resilient even if the Fed delivers a hawkish message, as it is already priced in by the market.
- At 3:57 - "Since the Fed began what I'm calling DT, duration tightening... they're reinvesting their mortgage-backed securities paydowns into Treasury bills, not into Treasury notes. So that means they're buying 17 fewer billion per month of... five-year Treasuries." - Barry Knapp explains his concept of "duration tightening," a subtle but important form of monetary tightening through the Fed's balance sheet management that puts upward pressure on long-term rates.
- At 7:11 - "In the crypto world, QT was draining liquidity. So the ending of QT is essentially QE... That is why I think crypto prices have risen in anticipation of this meeting." - Tom Lee clarifies that for risk-on assets like crypto, the cessation of balance sheet reduction is a major liquidity event, effectively acting as a form of easing that supports higher prices.
Takeaways
- Analyze both rate and balance sheet policies. The Fed's decision involves more than just the headline interest rate. Pay close attention to any changes in its balance sheet strategy (QT/QE), as this provides a separate, powerful signal about liquidity conditions that can significantly impact markets.
- Different assets respond to different Fed signals. While equities may be focused on the path of rate cuts, assets like Bitcoin are highly sensitive to overall liquidity. The end of QT, even without rate cuts, could be a major tailwind for crypto and other speculative assets.
- Watch the yield curve for clues on the banking sector. The Fed may be inclined to cut short-term rates specifically to steepen the yield curve, which would improve the profitability of small and regional banks. This could create a targeted investment opportunity in the financial sector, even if the broader economic outlook remains uncertain.
