The Fed Gut Punches Biden And Gives Global Leaders That Sinking Feeling — How Money Impacted GeoPolitics This Week

The debt-ceiling impasse is making the world shudder at the thought of a triumphal the return of Donald Trump, or someone equally chauvinistic on the GOP side, as Joe Biden gets boxed in and likely loses yet more of his leftist base in the Democratic Party. The Fed did its part to foment this political angst in handing Joe Biden’s economy a double whammy of punishing monetary policy. Yet today’s ebullient jobs report is erasing yesterday’s nasty thoughts of a market meltdown, as the bulls retake control on the flamboyant belief that a soft landing is happening, failing banks and falling liquidity and dreadful domestic politics be damned. Futures are rallying while the volatility risk premium is pointing to a range-bound market over the next few days and my technical reading of key stocks in the S&P 500 is neutral. Yesterday's cross-asset action brought several positive factors for US stocks. The action in major currencies indicates the $US is weak. 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. Gold is trading as a risk-off asset. Expect the S&P 500 to rise modestly toward 4210 over the next few days.

The Fed’s decision to raise rates in the face of a crisis of confidence in regional banks makes the debt-ceiling debate more likely to end badly than to be solved. Another credit rating downgrade is possible simply because the Fed has boosted the GOP’s hand, substantiating their argument that deficits are growing out of control while interest payments are crowding out all the spending priorities Democrats love. By making the credit crunch more severe the Fed has guaranteed a recession and higher short-term borrowing costs, all of which reduce revenues and increase interest payments (to the extent the Treasury issues short-term bills), taking high deficits yet higher. Biden is thus further boxed in by the GOP and given his weak standing with Democrats, is more likely to go the distance in protecting democratic priorities, leading to an impasse by end of month that possibly elicits another debt downgrade.

On top of this the Fed decreased the balance sheet at a higher pace than in previous weeks, putting QT back in the driver’s seat and lowering liquidity across the economy. The balance sheet fell by $59b, as bank loans declined by $16b, and QT measures helped offset a large decline in the Treasury’s account. As the government spent tax receipts and put money back into the economy the excess reserves of the banking system increased by $34b, partially offsetting the balance sheet reduction. While the effects of monetary policy are uncertain in timing they are certain in direction, and the economy will eventually slow materially and hit recession as reduced liquidity, reduced credit and deeper distrust in government grows.

But the bulls can rejoice in liquidity coming from elsewhere, as China’s PBOC is highly likely to boost liquidity and perhaps cut the reserve ratio, fed by recent IMF suggestions. Japanese liquidity is also remaining strong as yield curve control continues to be pushed out. This is leading to a slower decline in global money, as the M2 money supply contraction eased in March from -4.7% to -3.1% per Yardeni Research calculations. And the bulls can even claim that financial risk abated, as the BIS noted last week that cross-border bank credit growth contracted in 4Q22, making it likely growth is contracting this year too. While international credit growth is still high, the recent pullback is welcome since it follows an unhealthy surge in credit provision last summer that exacerbated the equity sell-off in October, as banks quickly pulled back and forced margin covering.

While the bulls are taking higher deficits to mean more GDP growth, higher rates to mean a normalized financial system and more money for retirees, and higher Asian liquidity to mean more robust global growth, the jobs report offers a more rational indication of the future: manufacturers are decreasing employment faster than previously reported. This correlates with poor productivity data, as services continues to grow and offer the low productivity expansion that indicates lower future growth. As the bulls recognize the impact of lower growth on lower earnings, equities will correct and retest the October lows, yet another jab at Joe Biden’s chances for reelection.

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.