Fed Chair Powell And Bond Traders Recall The Go-Go 1980s Happened Only After A Devastating Recession — What Fixed Income, Currency, Commodity And Equity Markets Are Telling Us

As Jerome Powell grudgingly admitted the housing market needs a difficult correction so too did the equity bulls admit their lost cause. The markets tanked yesterday and signal not only a retest of the June lows but growing concerns that many things may break as the Fed vainly tries for a soft landing. The volatility risk premium points to a market fall over the next few days but my technical reading of key stocks in the S&P 500 is neutral. Yesterday's cross-asset action brought one positive factor for US stocks: inflation expectations are stabilizing based on measures of Treasuries and TIPS. But there were also several negative factors across global asset classes: the action in currencies signifies $US strength and the US yield curve is inverting to 1980s levels. Expect the S&P 500 to be range-bound over the next few days before resuming its stairstep pattern back to the June lows and eventually much lower lows into 2023.

Bonds are reflecting fears of a long but normal recession that resembles the 2001 or even 1990 recession rather than the short-sharp-stoppage of 2020. But those recessions didn’t feature 9-10% inflation rates like we have now, and the prospects for a 1974 or 1980 recession (when inflation did reach current levels) is increasingly weighing on the minds of investors. Since bond market volatility remains elevated and yesterday’s reaction to Powell featured profound inversion, I expect the yield curve to worsen and invert slightly more over the next two weeks. Equity investor pessimism will follow and send the S&P to its June lows and well beyond as 2023 approaches.

There is no stopping the $US now as both the Indian rupee crashed through resistance and the Bank of Japan’s intervention (apparently one-sided) did nothing to break the ¥’s downtrend. Stronger economies with relatively robust interest rate regimes (eg Mexico, Indonesia) are holding their currencies steady but tellingly its America’s key allies that are losing out (e.g., the UK, EU, Japan, the Philippines). The geopolitical implications are complex as these nations don’t benefit much from depreciation due to the energy crunch, but neither does the American blue collar workforce that Biden cherishes. Pessimism about geopolitical trends will be the tipping point that sends equities well beyond the June lows.

Commodities are mixed but mostly range bound, signaling that disinflation will be slow particularly as firms are still passing through higher costs incurred over the summer. Fossil fuels are consolidating, foods and softs are mostly consolidating while metals are mostly heading lower. Equities bulls are betting that disinflation comes faster than profit margin compression but it’s more likely the obverse that will happen, and force valuations lower as earnings growth stagnates.

My current positions include a large cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), and SPXU, all of which still nets out to a meaningful short position in equities