The Fed Surprises As Economic Crosscurrents Choke Off Its Options — The Latest On The Global Economy

The Fed is highly likely to deliver a surprise to markets, either via a pause in hiking interest rates or an extremely dovish press conference and revelation of significant dissent that accompanies a rate hike. The implications for markets are huge: a pause would paradoxically hurt equities, as this would confirm what oil, copper and zinc are telling us, namely a declining global economy. But a hike with a dovish presser would confirm the rates market forecast of cuts this year, and send equities right to resistance at 4210. Clearly the markets were uncertain yesterday, but the volatility risk premium is pointing to a range-bound market over the next few days, while my technical reading of key stocks in the S&P 500 is bullish. Yesterday's cross-asset action brought several positive factors for US stocks. The US yield curve is falling and in the current context that is bullish. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. But there was also one negative factor across global asset classes. Copper and Oil charts are pointing to declining global GDP expectations. Expect the S&P 500 to rise over the next few days toward 4210 unless the Fed delivers the shock of a market lifetime.

The Fed is in a bind of historic proportions as inflation remains too high across the West. The Fed’s preferred gauge of US inflation is stubbornly 100% above the levels denoting price stability, while in the Eurozone it’s above 6%. But across the West lending standards have tightened substantially, manufacturing has fallen and retail sales are showing tentative signs of cracking. In a previous era this was known as the beginning of stagflation. Were it not for the terrible decisions of regional banks the Fed would continue fighting inflation based on the experience of that era, but now the Fed is set to pause and perhaps start cutting.

A Fed pause is also good politics. The US federal deficit is rising substantially, a fiscal stimulus that is keeping the economy positive despite the credit crunch and manufacturing slowdown. But due to past rate hikes, interest on the debt is crowding out spending and leading to the debt limit showdown. That showdown is yet another reason that equities are at risk of a major correction driven by economic fundamentals.

Asia is a relative bright spot that provides not just confidence but liquidity to global markets. China’s manufacturing is once again declining but services are growing as internal travel booms. China’s housing market is also robust, so the reopening is proceeding but at a less than sparkling pace. India continues to grow and is less vulnerable to global confidence due to high confidence in its autocratic leadership and huge capital spending. But Japan continues to muddle through and other Asian markets are highly dependent on China staying the course of moderate growth. This less than scintillating context explains the action in commodities and suggests that the equity bear market rally is coming to a close.

My current positions include a very large cash position, 3M (MMM), Pfizer (PFE), the levered ETF UPRO and inverse levered ETF SPXU, all of which net out to a modestly long position in large-cap equities.