The Fed JUST Issued a New Warning. Damn.
Overall Thesis
The Federal Reserve's planned $1.5 trillion balance sheet reduction starting Q1 2027, combined with expected rate hikes through mid-2027, will create significant market headwinds despite the creator's overall bullish stance.
Narratives
Kevin frames current inflation pressure as largely oil-driven, noting that forecasters keep pushing back the expected inflation peak because of oil price shocks. He speculates that a potential Iran and Russia-Ukraine peace deal could send oil prices sharply lower, which would ease inflation and change the Fed's rate path, but he frames this explicitly as a hypothetical scenario rather than a firm call.
Key Arguments
- Goolsbee says inflation keeps failing to peak because of oil prices, which is 'not a comfortable pattern'
- Schmid notes inflation across goods and services is running hot and 'oil is not the only driver'
- A resolution to the Iran and Russia-Ukraine conflicts could crash oil prices and reduce inflationary pressure
Kevin discusses a projected $1.5 trillion Fed balance sheet reduction beginning as early as Q1 2027, which he says would work out to roughly $62 billion per month being pulled out of the market via passive treasury runoff. He argues this tightening could push yields higher in 2027, raising financing costs for AI infrastructure and acting as a market headwind, while he remains bullish for the remainder of the current year.
Key Arguments
- Morgan Stanley projects $1.5 trillion of balance sheet reduction starting Q1 2027 over roughly 2 years, about $62 billion/month
- Passive runoff means the Fed stops buying 2/5/10-year treasuries, which could push yields higher
- Higher yields would raise financing costs for AI infrastructure buildout, a headwind for 2027
- Market is pricing four rate hikes through mid-2027 but Kevin and Morgan Stanley expect fewer (around two)
Predictions (1)
Hedges & Caveats
- Creator states 'I'm still optimistic and bullish' despite identifying headwinds
- Morgan Stanley's predictions about balance sheet reduction timing and methodology are not guaranteed
- Rate hike expectations are based on current market pricing which could change
- The creator acknowledges Morgan Stanley believes markets are pricing in too many rate hikes
- Inflation trajectory remains uncertain with conflicting signals from different time horizons