Hi YXI friends,

It may have been 6 weeks since the December FOMC - we’ve had Christmas, New Year, and the Lunar New Year in between - but it is difficult to forget the immediate market turmoil caused by the Federal Reserve’s hawkish cut on December 18th.

SPY (the S&P 500 index tracker) tanked by 4% before finding a low, while a Santa rally fizzled out shortly after the Boxing Day.

The key question is, can the Fed do it again? The market is already in high anxiety after Monday’s DeepSeek selloff.

Being up 3.1% YTD means SPY has enjoyed the 8th best start in 30 years, but investors are still stuck in the “Fear” mode according to CNN’s Fear and Greed Index.

Table of Contents

• 1. DeepSeek or Yen Carry?

• 2. Market Prediction Of The Fed Path

• 3. “Will You Listen To The POTUS?”

• 4. TLT Analysis

• 5. Pre-Earnings Analysis: MSFT, META, TSLA, NDAQ

  • Microsoft: MSFT

  • Meta: META

  • Tesla: TSLA

  • Nasdaq: NDAQ

DISCLAIMER: This newsletter is strictly educational. Any information or analysis in this note is not an offer to sell or the solicitation of an offer to buy any securities. Nothing in this note is intended to be investment advice and nor should it be relied upon to make investment decisions. Any opinions, analyses, or probabilities expressed in this note are those of the author as of the note's date of publication and are subject to change without notice.

1. DeepSeek or Yen Carry?

DeepSeek outperforms US AI

Every media outlet this week has the “DeepSeek” narrative front and centre of their market coverage. A supposedly $6 million budget AI model is outcompeting the deep pocketed Open AI models at least in term of cost effectiveness. This calls into question if the US AI leaders are way overspending on CapEx, and whether the likes of Nvidia and AMD will see much lower demand for their cutting-edge chips in the coming years.

Today, there were accusations that DeepSeek using Open AI’s models for training (“distilling”) and that they actually spent hundreds of millions in research and development. The app also stores all the key information in Mainland China and now doesn’t onboard users without a Chinese phone number.

I think all of the above is really just noise.

My suspicion is that low-cost models may actually help wider AI adoption on the application layer, potentially leading to higher infrastructure spend down the line. This is like how the smartphone industry was initially kicked off by Apple, but every person now uses smartphones from every phone brand, with huge ecosystems of apps built on top. AI goes much further than the text or image-based outputs that we have today.

For example, Meta is going to spend $65 billion to expand its AI infrastructure this year so its clients can create imagery and video creatives for advertising directly on Meta’s platforms. If achieved, this can be extremely valuable for everyday business who don’t have big marketing or production budgets. Moreover, we are still far from Artificial General Intelligence - until that day comes, firms will continue to invest heavily to push the frontier of AI.

The Real Reason - Bank of Japan

Now let’s get to potentially the real reason that market sold off on Monday, which was that Bank of Japan hiked rates from 0.25% to 0.5% on Friday. Moreover, BOJ signals that they will raise interest rates again in June or July. The base rate could go above 1.5% in the next two years.

USDJPY vs QQQ

Yen is a funding currency for the carry trade, which famously caused a market meltdown last August. Private funds often borrow in Yen at a very low interest rate, swap it to US Dollars, and invest in higher return bonds or equities. This trade is not risk free - US equities can go down and USDJPY can also move against them. But if Japan’s interest rate goes up (including the forward expectations), it would squeeze the cost of funding for carry traders. In an event of unwinding, US risk assets can drop.

While we do not have the exact carry trade figures since last August’s blow up, we observe a directional relationship between USDJPY and QQQ - not perfect, but also not small enough to ignore. Monday’s market selloff coincided with the aftermath of BOJ’s rate hike and Yen’s rally.

2. Market Prediction Of The Fed Path

Going into the FOMC, the market prices in exactly 2 cuts in 2025, putting the terminal yield at 3.83%. This is a touch more dovish than the beginning of the month, but pretty much where the December FOMC’s Dot Plot projects.

Market Pricing Via Fed Funds Futures

First, there is a virtually zero chance of a cut in the FOMC today, despite Trump calling for one.

Earlier this month we had a strong set of Nonfarm Payrolls with unemployment tightening to 4.1%. This gives the Fed a lot of comfort to solely focusing on inflation right now. My read is that the Fed won’t get alarmed unless the unemployment rate quickly shoots to 4.4% (above their estimate for 2025). While the latest CPI data were more benign, it is insufficient for the Fed to make a move.

The Fed Funds Futures suggest that the market does think the Fed will cut again before end of Q2, but the exact timing is uncertain. In reality, the timing of cut will heavily depend on the next 3 sets of CPI & PCE data. Back in 2024, we had a string of hot beginning-of-year inflation data that scared the Fed into postponing the cuts. The Fed is definitely concerned about a repetition of last year, as well as the potential inflation impact of Trump’s tariff policies.

On the tariff front, it is actually still unclear what the broader strategy is, even as we move towards the crucial February 1st for starting 25% tariffs on Canada and Mexico and 10% on China.

Scott Bessent, the Treasury Secretary, is floating the idea of starting with 2.5% and gradually raising the tariffs each month. Trump, however, favours a much bigger size to start.

Neither the Fed nor the market like uncertainties, which means tonight Powell will continue sounding cautious about the next cut until they can see more inflation data and tariff plans.

Finally, the next set of Economic Projections from the Fed is only released in March, when they will renew their Dot Plot, inflation estimates, and labour market assessment.

The above should make today’s FOMC a non-event, but for one question.

3. “Will You Listen To The POTUS?”

Last Thursday in Davos, Trump demanded that “interest rates drop immediately” and “I think I know interest rates much better than they do, and I think I know it certainly much better than the one who's primarily in charge of making that decision”.

The reporters at the Press Conference will most certainly throw Trump’s comment to Powell, asking if he would listen to the POTUS.

Powell is incentivised to keep the answer as short as possible to avoid distractions to the rest of his comments, but it is an inevitability that his answer will become on the front page.

The correct answer is along the lines of, “The Fed is an independent body that is appointed by the Congress to tackle the dual mandate of Maximum Employment and Price Stability. We believe achieving these two goals are in the interest of the American people. We will do whatever is appropriate to achieve our mandate”.

But the media may insist on a more direct “Yes or No” answer from Powell, “So you won’t listen to the President’s demand?”, which is then taken as a refusal to cut rates.

Powell may follow up highlighting that he has weekly lunches with the Treasury Secretary (Scott Bessent) and the Fed works closely with the Treasury. This may be interpreted more dovishly without Powell looking like “fight or flight”.

4. TLT Analysis

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