The Fed Pushes Back Against Biden’s Federal Government But The Bulls See No Contradiction Here — How Money Impacted GeoPolitics This Week

Today’s extraordinary labor market report provides both bullish and bearish indications that all boil down to how the Federal Reserve reacts. The talk concerns interest rate decisions but the real issue is what happens to liquidity. National politics marries intimately with monetary policy in this regard as the Fed must decide what to do given the large debt issuance that’s likely to come. The bulls are in control and clearly betting the Fed doesn’t take the punch bowl away, as 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 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. The action in currencies signifies $US weakness. Expect the S&P 500 to rise modestly over the next few days toward 4300 before coming down hard.

The question silently dogging the markets is whether the Fed punishes market ebullience with continued QT despite the imminent liquidity drain that a replenishment of the Government’s account will occasion now that the debt deal passed. Over the past week the Fed allowed the balance sheet to decline by $51b as QT reduced excess reserves by $45b while other elements stayed nearly level with the past week. The bulls need the Fed to accommodate the Treasury debt issuance since by other measures liquidity continues to decline.

Risk.net notes “Collateral velocity fell in 2022 for the second year in a row, despite healthy levels of eligible securities available for re-use. The trend likely reflects balance sheet constraints at global investment banks and the growing footprint of central banks in markets. It also bolsters the case for upgrading the plumbing of the markets with new technology to improve collateral efficiency.” The internals of the money markets point to grave risks to liquidity since collateral velocity is a key multiplier that defines how fluid banking relationships are, and by extension how much credit flows both to securities markets and the real economy. The ECB made a similar point this past week in noting “Market liquidity conditions in the euro area sovereign bond market have deteriorated below the sample average since mid-2022 across many dimensions, to similar levels seen during the outbreak of the COVID-19 pandemic in 2020”

The bulls are ignoring these warnings at their peril in the vain belief that the monetary authorities care nothing for cultural and political trends that drive the work ethic lower and vitiate the efficiency of capitalism via rising statism. I see this as preposterous given the shared educational and cultural context the monetary authorities bring to their collective decisions, and expect dampening liquidity to strafe the megacap techs and global equity markets as June unfolds.

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