Bond Traders And Eurasian Autocrats Get An Earful Of Hawkish Fed Rhetoric, But Equity Bulls Aren’t Listening — What Fixed Income, Currency & Commodity Markets Are Telling Us

Despite a chorus of Fed voices for fighting the good fight against inflation expectations the equity bulls have taken control of the markets and saddled the world with another monstrous bear market rally. And while Eurasian autocrats from Russia to Iran devastate their people and inadvertently keep commodity prices high for the rest of the world, the bulls sing like Pollyannas about supposedly easing inflation and a munificent pause in Fed rate hikes. Nothing will have changed by late October as equities round-trip back to last week’s lows, but for now the volatility risk premium points to a higher market over the next few days, while my technical reading of key stocks in the S&P 500 is short-term bullish and long-term bearish. Yesterday's cross-asset action brought several positive factors for US stocks. Gold is projecting $US weakness. Copper's chart is signifying global growth. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. But there was also one negative factor across global asset classes. Oil is pointing to stagflationary conditions. Expect the S&P 500 to rise over the next few days before cratering after earnings season kicks off next week.

Fixe income markets have rallied of late and sent $US bulls into forced sleep as optimism about a Fed pause before the mid-term elections ramps up. I see not a pause but a slight waning in the intensity of Fed rates hikes, which will continue until the Fed Funds Rate is in restrictive territory (i.e., 4.50% +). The persistence of the high core rate of inflation near 5% is the culprit, and the philippics of leftist politicians can’t do anything to change that. Inflation is baked in for months yet and the Fed doesn’t want to lose the fight nor sanction the higher wage demands, unionization drives and non-participation that characterize much of the American labor scene.

The Fed is justified in fighting inflation trends, so they can get away with silence on the recent labor market dynamics they detest. Pass-through lags and a raft of resurgent commodities suggest inflation will persist, and that raises the 1970s phenomenon of persistent inflation expectations which begin the vicious cycle of ever rising inflation driven by entirely rational behavior. Precious and industrial metals have started breaking out while fossil fuels are trying to shake off the bottoms of the past month. Gasoline in particular looks especially worrisome from an inflation standpoint. The latest OPEC news and Biden’s foolish bout of public frustration means more Americans will hear about inflation as well as see it at the register, forcing the Fed to keep interest rates higher for longer in order to vanquish this “inflation in the mind” that drove the dysfunctional 70s.

Most food commodities have stabilized and look to move higher, another unpleasant sign for the Fed, while soft commodities are still in downtrends. Until we see most commodities in downtrends and drops in the headline rate of inflation the Fed will not only keep raising rates but also maintain its stern QT program of taking liquidity out of the market and the economy. A world of persistent inflation and declining liquidity guarantees tighter profit margins and as earnings report bear that out next week the bear market rally will abruptly end. Look for lower lows in the S&P by late October unless a commodity bear market can do the work for equity investors.

Yesterday I exited the incremental short position I had initiated Tuesday, via the inverse levered ETF SPXU. 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.