Interest rates and South of the Border

September 21, 2022

Investors are sure whoopin’ it up the last few days. Fed chair Powell essentially guaranteed another 75 bp rate hike at next week's FOMC meeting. This will take rates to 3.25%. And the belief is that 4% is the silver bullet for inflation.

The Fed can hit that 4% mark in the next few months. And inflation has come down a little. So I suppose it’s easy to imagine that rate hikes are working and the Fed will indeed engineer the desired soft landing. Get to 4% and we can flip the bull market switch back to “on.”

Now I gotta sidetrack a little. Aside from a few very well spent years as a ski bum in Colorado, I’ve lived in Richmond, VA and Baltimore, MD. I’ve got a lot of family in Charleston and Columbia SC. And I just recently moved to the southern coast of Georgia.

I’ve probably traveled I-95 between MD/VA and SC/GA a hundred times. As kids, my brother and I would start the “dadddaddaddaddad” chant as soon as we saw the yellow sombrero of South of the Border (it’s a typical roadside attraction with a hispanic motif, complete with motel, putt putt, discount cigarettes and a small broken down roller coaster). 

Dad’s answer was always the same: “Nope. Tourist trap.”

South of the Border is a creepy looking place. There’s just no reason to stop there. And I never have, except once and I wasn’t driving and it wasn’t my idea and I stayed in the car because I don’t wanna be kidnapped by the meth addled truck stop hookers I’m sure are the only people lurking around the seedy looking South of the Border motel. (They checked out a long time ago, but they don’t wanna leave.)

This is how I feel about 4% rates. It might look good from the highway, but it’s a trap and there is no reason to stop there. And in fact, there are very likely hidden dangers lurking at 4% if Fed chair Powell decides to stop the family car there for a little R and R. (If you give this man a ride, sweet family will die.)

Just like South of the Border, 4% interest rates are a gimmick. I’m not sure exactly when 4% became the destination. But I can tell you — 4% is a completely arbitrary number that the Fed chose months ago, hoping that inflation would abate in the time it took to get there.

When you get about 100 miles from South of the Border, the “Pedro Says…” billboards start. These billboards serve a very important marketing function. They are the hype machine that drives traffic to South of the Border.

The Fed markets its plans in the exact same way. The first 75 basis point billboard we saw, it was holy crap, that’s insane! Couple more billboards like that and investors couldn’t wait for 75 bp hikes, and in fact, would be very disappointed if the Fed didn’t deliver a whole bunch of 75 bp hikes.

Now let’s turn our attention to investment banks like Goldman Sachs, JP Morgan, etc. These are the guys that actually post the billboards. The Fed leaks 4%to Goldman Sachs, and then some Goldman Sachs guy tells the Wall Street Journal that Fed wants rates at 4% and pretty soon, voila!, 4% it is.

Now let me ask you this. Is Goldman Sachs celebrating the end of the bear market and inflation? Well, they announced hundreds of layoffs today and the word is GS will see a 40% drop in earnings this year.

Are investment banks getting bullish, raising their year end targets for the S&P 500? Well, Bank of America is still sitting on its call for the S&P 500 to end the year around 3000, about 25% lower than it is right now.

Always remember, the name of the game is buy low, sell high. If the investment banks can put up a few billboards for the Fed, and get investors excited that there’s a destination in sight, they will do it cuz it gives them a chance to at least sell at short term highs.

Just look at today’s action. Stocks are getting pounded because this morning’s inflation data didn’t fall as much as hoped. And so maybe 4% isn’t going to cut it. It’s like pulling into that South of the Border parking lot and thinking, “Holy crap, is that a meth addled truck stop hooker lurking over there? Maybe we should stop someplace else…”