[DDIntel] Fed Moves, Dollar Economy, and GPT-based Research

May 14, 2023

*Better than ChatGPT: The AI Breakthrough That Could Change Everything, by Mike Hassaballa*

Jerome Powell, the Federal Reserve (Fed) Chairman, recently announced a small but significant increase in interest rates from 5% to 5.25% to combat inflation, raising interest rates the 10th time since last year. However, Powell is now being criticized for increasing interest rates in the middle of a banking crisis, which has increased the risk of a full-blown banking crisis and put the final nail in the American economy.

The Federal Reserve is caught in a difficult position, as it has to choose between dealing with soaring inflation or the risk of a banking crisis. Reducing the money supply through Quantitative Tightening, as Powell has done, has the effect of removing liquidity from the economy, but it can cause companies and businesses that rely on borrowing to be at risk of being wiped out.

Such a situation has occurred a handful of times in modern banking history, including the Great Depression (1929–1939), the Volcker Shock (1979–1982), and the Global Financial Crisis (2008–2009). Each time, what followed was either a catastrophic recession or a depression.

Powell has claimed that the banking system is sound and resilient and that the Fed is making its decisions based on what's best for the American people, including creating jobs and keeping prices steady. While Powell's decision to raise interest rates has garnered criticism, he is committed to bringing inflation down to the target rate of 2%. But will he succeed in doing so? Or is this the final nail beaten into the American Economy’s coffin?

The Final Nail in the American Economy

The federal reserve is not the only hot news that will affect our future. In recent weeks we saw major central banks announcing their monetary policies, causing volatility across various assets. With signs of bottoming out and inflationary pressures building, some are calling for a stagflationary outcome. However, there have been flip-flops in data since January due to various reasons, including seasonal effects and pessimism among consumers.

The Bank of Japan stunned the markets by announcing a 12-18 month period for the normalization of policy, which involves abandoning the Yield Curve Control. Japan's biggest source of inflation has been "imported inflation" due to a depreciation of JPY by over 25% in the last year. The BoJ projects stable core inflation of around 2.5% till 2025 before falling to their long-term target of 2%. However, structural changes in the labor market and rising inflation expectations are obstacles to lower inflation.

The Federal Reserve and the ECB are also monitoring the situation. Jerome Powell expressed concern over the spread between bank deposit rates and Money Market Funds. Regional banks, office CRE, opaque private markets, leveraged loans, and multifamily housing pose real risks.

To make informed investment decisions, it's crucial for data-driven investors to grasp the variable lags in the data and gain a macro-level understanding of business cycles. We need to understand that central banks face challenges like a changing labor market, rising inflation expectations, and vulnerability in the financial system. While normalization of policy is inevitable, central banks are closely monitoring the situation to avoid drastic consequences - and we must monitor their moves.

Banking - Beginning Of The End!

While the Fed Rates and Banking System keep being in a weird spot, it’s extremely important to choose how to invest. It is well known that when it comes to investing in the stock market, there are two major options at play: large-cap stocks and small-cap stocks. The former belongs to well-established and stable companies with a market capitalization of over $10 billion, while the latter is comprised of smaller, nimble businesses with a market capitalization of less than $2 billion.

While large caps are less volatile and less risky, small caps have higher growth and returns potential as they are quicker to integrate innovative solutions. However, individual stock investment can be overwhelming, and matching the market through index investment might be a better choice.

Major indices like the S&P 500 include large caps, while small caps can be found in the Russell 2000. Besides choosing between large and small caps, investors can also consider value or growth stocks. Value stocks trade at a price lower than their intrinsic value, while growth stocks are those with a high potential for future growth.

At the end of the day, investing in the stock market is a long-term game, and picking individual stocks can be challenging even for professional money managers. Index funds and exchange-traded funds offer a more diversified and low-maintenance investment option for those who do not wish to engage in extensive research and analysis.

Investing: Growth or Value?

If we speak about investments, we cannot ignore the power new AI technologies bring to the acceleration of investment research and analysis, as more significant breakthroughs are being developed. Language models are quickly becoming the new buzzword in investment research, with both startups and established companies jumping on board.

One example of this is BloombergGPT, a hybrid LLM (Large Language Model) that combines 50 billion parameters from its own data and online text datasets. This financial powerhouse hopes to create a digital assistant that can provide accurate financial information and even analyze the sentiment of news headlines.

Microsoft is also getting in on the action by integrating Copilot into Excel - a major milestone in the integration of LLMs into existing applications. AWS is proposing the fine-tuning of GPT-J 6B for financial text generation, a smaller and more cost-effective model that's perfect for narrow tasks.

However, there are trade-offs between cost and objective, so it's important to keep a human eye on these models to ensure accuracy. Ultimately, using LLMs in domains where you already have some knowledge is key to ensuring plausibility and verifying sources. What’s sure is that everyone will harness the power of these LLMs to create a smarter, more informed financial future. And so should you!