Bond Vigilantes Throw Joe Biden’s Economy Up Against The Wall While The Fed Polices With A Soft Touch —What Fixed Income, Currency & Commodity Markets Are Telling Us
Comeuppance has risen with a fury against American workers, bullish investors and the President as interest rates react to an outsized inflation report. With the Fed watching patiently as the pain deepens only a Lehman moment can pull rates down and save equities from lower lows. The volatility risk premium points to a higher market over the next few days due to drop in actual volatility yesterday, but my technical reading of key stocks in the S&P 500 is bearish. Yesterday's cross-asset action brought one positive factor for US stocks. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. That metric may change dramatically over the course of today if this morning’s action is any indication. Expect the S&P 500 to fall over the next few days and force more bulls to capitulate as the economic trajectory grows murkier.
Today’s CPI report shows sticky inflation driven in part by wage demands from a complacent American labor force. The Fed is culturally averse to this but maintains silence about the dynamics leading to such complacency, namely burnout and disillusion with the virtues of dynamic creative destruction. The Fed reasons that Americans need a reset, not a rest, and a recession can potentially do that. For the Fed it’s more rationality that’s needed, not higher wages chasing high inflation. The American worker benefitted temporarily from Biden’s stimulus and should now pay it back with real wage decline, according to the Fed. And in a convenient turn to egalitarianism, the Fed reasons that markets should give back what they got over the past two years from QE. Consequently there is no Fed put on lower equities and bonds, only a careful watch for a Lehman moment.
With commodity prices stabilizing this week such a Lehman moment looks less likely on the Central Counterparty (CCP) front. High leverage based on inadequate margin and capital requirements is a major source of global financial instability, but thankfully this looks unlikely to manifest in the immediate term as commodities stabilize. The fossil fuel rally is petering out, metals are consolidating while foods, meats and softs are differentiated but as a group stabilizing. That spells good news for future inflation. Unfortunately the Ukraine war and related volatility in the $US could move commodities higher next week and stall the disinflation the world desperately craves.
EM and DM currencies alike have risk to the downside, as rising US rates pull in money from global investors. Today’s action in treasury rates will be critical to determining whether rates stabilize or have higher to go on the fear that the Fed will raise rates above 5%. The action this morning suggests a poor day for bonds, and consequently more volatility in FOREX. This would mean both potential instability from esoteric corners like UK pension funds, but also a prolonged bear market in the S&P.
My current positions include a large cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), and the inverse levered ETF SPXU, all of which still nets out to a meaningful short position in equities.