Equities Will Crack Sooner Than The Fed’s Persistence, According To Everyone Except The Bulls — What Fixed Income, Currency & Commodity Markets Are Telling Us
Volatility is set to pop with today’s strong economic data, but a bigger pop lies down the road as equity investors come to grips with nearly a year of fighting the Fed. The rest of the financial markets have largely acquiesced to the Fed but equities are powered by large cash balances and euphoria over AI and likely to move yet higher in this inexorable melt-up. Presently the volatility risk premium points to a higher market over the next few days (though volume may be light since the VRP could easily reverse and catch investors offside), while my technical reading of key stocks in the S&P 500 is neutral. Despite the bullish feel here are several negative factors across global asset classes. The US yield curve is rising and in the current context that is bearish. Inflation expectations are rising based on measures of Treasuries and TIPS. Expect the S&P 500 to trade in a tight range over the next few days.
Bond volatility has been creeping up while actual equity volatility is testing lows not seen since the raging bull market of 2021. This divergence will resolve to the downside since equity volatility is far below the norm and so must revert eventually. The rise in volatility may be due to unforeseen geopolitical events but could easily arise because of the strong economy contrasting sharply with the Fed’s intention to decrease liquidity. The Fed is likely to stay on its path absent a break in the financial system since disinflation is simply not strong enough to warrant easy money.
Wages are still rising nominally and with low unemployment the disinflation in services is not strong at all. Offsetting this is commodity disinflation, which has been profound but may be bottoming. Fossil fuels are consolidating and likely to rally to resistance levels, temporarily stanching the disinflation trend that’s given us sub-4% headline inflation. But precious metals are trying to bottom and fighting the trend in interest rates, which are heading higher and raising commodity carrying costs. Industrial metals are in generally weak and set to move lower, while most ags, meats and softs are coming off rallies and set to move lower. Until unemployment rises and gives a fillip to the disinflation trend the Fed has little reason to ease on the brakes and that will eventually break this bear market rally.
My current positions include 3M (MMM), Pfizer (PFE), and a large position in SPXU, which nets out to an extremely short position in equities.