Fed Capitulation Near?

The high drama playing out in the financial markets has been an earthquake with the UK at the epicenter. The BOE stepped in today with a safety net for the plunging UK bond market, sparking a rally across global markets notably including US Treasuries, stocks, gold, copper and oil. In other words the US dollar gave back some of its recent gains versus just about everything else under the sun. The celebratory mood in Wall Street and Silicon Valley reflects hope that their gravy train will keep on running, not new hope that middle America will regain any of the prosperity it has lost to the bicoastal elite over the past two or three decades.

But maybe that is reading too much into a one day spectacle. As they age, trends tempt momentum players in and money piles up on one side of the boat. Short positions in stocks, bonds and commodities against the dollar have grown too large. Everyone profiting from the same trade is impossible, so the boat must lurch the other way.

Another way of saying this is bonds, stocks and commodities were oversold and the US dollar overbought. The difficulty for traders and investors is gauging whether the reaction represents a sustainable trend change or a transient correction.

I don’t pretend to know. With the tools at my disposal however, I continue to think US stocks are not only vastly inflated and overvalued but underdiscounting the negative profitability outlook, while US bonds are overdiscounting how much the Fed will have to do to tame inflation. In short, stocks have come down less than they need to while bonds have come down more than they need to. If stocks rally very far, it will only encourage the Fed to grow even more resolute, so the balance of risks appears strikingly asymmetric. And while I think the market will come to see it my way, there are no guarantees whether or when, so while we can weigh them in favor of our expectations, it remains prudent to not bet all the chips on any one outcome.

In the financial media, however, today appears to be more about Wall Street self-serving and distortions than any genuinely good news. How much are stocks really up? And how much of this is actually dollar down? The S&P 500 is “up” 1.96% at the close. Gold is up 2.07%. Copper is up 2.98%. Oil 4.21%. Long term treasuries, as measured by VGLT (10-30 years maturity) are up a staggering 3.17%. (TLT (20-30 years) is up 3.35% and EDV (20-30 year zeroes – a close proxy for SS “Bonds”) is up 4.18%.) While talking heads wax giddy about supposed gains, the stocks of our great companies actually lost ground today to mere chunks of inert metal. It’s not a one day wonder either … they have the twenty first century to date.

But don’t expect to hear this on CNBC. Or Bloomberg, etc… because these outlets are there to market Wall Street and Silicon Valley, not the competition.

As we’ve remarked ad nauseum, when everything looks “up”, check your units. Check that you’re not standing on the deck of the Titanic claiming the ocean is rising. Indeed, the breadth of the price increases across asset classes leaves no other rational conclusion than the overwhelming move is in the unit of measure you’re using … this is a “dollar down” day. Many more days like this, and a dollar won’t buy you a stick of gum.

That’s what Wall Street media mouthpieces are celebrating. And it’s not good news for ordinary Americans, or … pointedly … for a Fed that for the first time in decades appears to be putting their interests first.

6 thoughts on “Fed Capitulation Near?

  1. Mega says:

    Bill
    Talk round the cap fire is that the FED just baled the BoE out.
    The system was about to implode ………Looking at falling $ & climbing £.
    There is much friction between Washington & London…..but i suspect they no choice.

    Mike

    1. Bill Terrell says:

      Thanks, Mike. I haven’t seen anything elsewhere about it one way or another, but it wouldn’t be surprising. Even as a congenital skeptic, I wouldn’t even call it inappropriate. The people of neither nation would benefit from complete systemic collapse.

      At the same time, there are a lot of parasitic players out there who profit from leveraged bets whose going out of business would benefit the average citizen. Something has to break; I just hope the breakage occurs where it’s needed most and not paid for by innocents.

  2. kbird says:

    I don’t think the Fed pivots until the market forces it do so, and, judging by the VIX, the market is pretty sanguine right now. Powell wants to not be this generation’s Arthur Burns which I think means keeping monetary policy tight until wage inflation comes down. I don’t think he will succeed, but I doubt he’ll pivot with the VIX at 32.

    1. Bill Terrell says:

      Thanks for weighing in KBird. Powell & Co are now in “nip it in the bud” mode. I agree Powell is probably thinking about his legacy .,. he does not want to be remembered as a Fed Chairman that unleashed a decade of inflationary misery.

      It matters less how fast stocks go down than how far they go down – they want “tighter financial conditions” – and another 10%-30% would do it. But they may nevertheless get it fast … the stock market has yet to fully price in the repricing that has already taken place in the bond market and a little more momentum may just get it there. As I speculated a few posts back, it’s not beyond the pale that it gets there before the next scheduled FOMC announcement November 2 … it could turn out that the Fed is already done hiking for this cycle.

      If we do indeed get those lower asset prices though, they will have succeeded. Asset prices are lead consumer prices. The question remains however whether it’s a mere temporary victory … if they come down but then shoot off to the races again, it will just be rinse and repeat.

      Wages will be less critical … if rates have put in a generational bottom and average higher over the coming years, the wealth gap will narrow. There is a strong inverse relationship between low rates and high asset prices on one hand and economic inequality on the other. Wages can rise in real terms representing a shift from capital to labor without overall inflation necessarily being higher.

  3. kbird says:

    If the Fed is thinking that lower stock prices leads to layoffs leads to more unemployment leads to less wage inflation, which I think is the case (regarding what the Fed thinks), then that would suggest that when we hit the right level in the stock market for the Fed it does not mean easing after that. It will likely just mean no more hiking.

    I think we may be coming back into an environment where it will make sense to buy stocks for the dividend yield.

    1. Bill Terrell says:

      Yes KBird I think you nailed how the Fed looks at it. For now they are singing a higher for longer tune. And while they certainly don’t foresee a hairpin turn from hikes to cuts, it depends largely on what the markets do. It’s admittedly an extreme scenario, but if we saw the S&P back near the 2009 lows aggressive cuts would be virtually assured.

      From my asset-price-inflation-leads-consumer-price-inflation perspective, the Fed needs maybe just one more big leg down in stocks … but more importantly … not to send them soaring again.

      I also agree about dividends … dividends are ultimately the only sustainable real return from stocks. Before the Fed introduced systematic inflation early last century, stock price increases weren’t the main thing investors looked to for returns … they were compensated for their risk taking with what would be regarded today as very rich yields.

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