Not Even The Bankers’ Banker Is Immune To Biden’s Push To Prioritize Everything: The Geopolitical — Stock Market Connection

The Federal Reserve used to talk as if it was only bankers who needed to understand them but in this polarized political environment the Fed has rightly learned to play good politics in order to safeguard its domain. Investors might be forgiven for looking the other way but since the geopolitical consequences of the Fed’s politics is profound it’s imperative to know when the Fed is putting politics above prudence. That’s the case today but investors aren’t listening, 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 action in EM currencies indicates the $US is somewhat weak. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. Expect the S&P 500 to rise modestly over the next few days to 4308 before falling hard.

The Wall Street Journal’s scoop that the Fed is planning to raise capital requirements likely deflected off the mindset of the broader public, as banks are flush with what most Americans dearly need. So inured are businesses and the public to more regulation and higher costs of doing business that even investors are focused on ebullient earnings forecasts rather than a cold assessment of this desultory reality. The Fed is supposed to serve the financial sector and has historically defended Wall Street, but even that pillar of capitalism has succumbed to statism, heedless of the geopolitical consequences.

Reuters notes “US regulators are considering raising capital requirements for large banks by as much as 20 percent, the WSJ wrote, citing people familiar with the plans. Last month, the US Federal Reserve's top regulatory official told Congress that the central bank would likely unveil its plan to ratchet up capital rules for banks this summer and ensure supervisors more aggressively police lenders following the bank failures.”

The Fed has political reasons for joining the statist parade: it intends to keep interest rates higher for longer and thus needs anything it can grab to ward off Democratic criticism as we head into an election year. So investors shrug this off as the necessary political costs of living in a more or less free society. But the geopolitical impact is profound and ignored. Statism is not just more state involvement in business practices and standards but also directing resources to national goals, via programs like the IRA, CHIPS Act, etc. Such statism is counterproductive as it increases financial fragility, since lending moves from banks to private credit and securities markets where relationships count less. This in turn means that when volatility periodically shocks the markets it gets amplified rather than checked because the banks no longer play a mighty role; instead the markets do that. The Fed might prefer that fiscal policy do the trick, but it has little choice since extending deposit insurance to cover larger deposits increases moral hazard, since it’s based on the noxious notion that depositors should feel entitled not to care about the prudence of their banks. So financial fragility increases as a result of macroprudential policies, par for the course in an increasingly topsy-turvy world.

But as Biden vitiates the efficacy of the American economic system the 2020s begins to look more and more like the 1970s, with its high inflation and encroaching role of the government, which is coincidentally when Biden came of age as a national politician. That decade of ill-conceived policies and destructive geopolitical trends resulted in the election of what was then the far-right figure of Reagan. An election of a far-right figure today would be devastating to America and the world as it would provoke deeper culture wars and leftwing paranoia, widening the gulf between America and its Eurasia as confidence waned. The logical end of this scenario would be the more proxy wars and less action to fight global ecological problems, further exacerbating the left-right divide and amplifying the cycle. If the Fed succumbs so easily to Biden’s statism then imagine with the GOP would do when it took control of the fiscal purse.

This is yet another reason a recession is in order for America, not just to wring out economic excesses and the cajole those nonparticipants to start working again, but to slake the tendency to increase the state. Recession would cause a widening budget deficit and result in more pressure to limit spending, while settling markets back into reality and providing a foundation for rational policies going forward. Expect investors to get this message soon as the Fed pauses to tell markets it intends to gets its way on the economy.

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.