This Wednesday the bulls will be all jacked up, sipping their Zimas and prepping for a massive market rally after Federal Reserve Chairman steps up before the microphones on September 17th and the SEPs are released to great fanfare reintroducing the hopes of easy money policies forever.
And rightfully so, except for the Zima part.
Theoretically, it would be “better” for the bulls to have a run of the mill 5, 10, or even 20 percent move to the downside to clear out the weak hands and wake up the retail gamblers that markets are priced on risk, not hopium.
Such a dramatic move to the downside would probably trigger panic at the Federal Reserve and perhaps even inspire the discussion of Quantitative Easing or at a minimum, the end of all QT(Quantitative Tightening) that has been ongoing for over a year now. That would of course provide a stupidity buffer or “safety bumpers” to the people who have speculated their retirements away. In this way they might perceive that another government or Fed bailout will preserve their financial well being and prevent a panic driven crash.
Instead, retail is taking the existing Fed policy and gambling on various crypto tokens, schemes, stablecoins, and of course, penny stocks like it’s September of 1929. That never ends well despite all of the cries that markets and banking have abolished the business cycle.
The problem is that when a crisis does occur this time, odds are markets will end up with a Trumpian Fed which will endorse Nixonian policies which result in a major risk of long term stagflation not identical to the 1970s, but just as painful for the credit dependent lower 70% of the American financial caste system as losses are socialized once again.
The 2007 Reminder
The last major recession event that most individuals remember was the Great Financial Crisis. The recency bias that most analysts and television talk show hosts reflects the “we cured all of the ills of that era” mentality.
While the odds of a repeat of the housing crisis of that era are low at best, the problems with credit, finance, and the ability of Americans to service the massive amount of debt incurred since the pandemic alone could be equally as problematic.
To understand this author’s concerns, let’s take a chart, perhaps another chart crime by yours truly, and look at the directional nature of the US Government 10 year yield versus the broad S&P 500 in 2007:
The “bulls” ignored the warnings of the US 10 year until late in the summer of 2007. When the Fed conducted operation “Screw the Shorts” by “allegedly” tipping off Wall Street about a soon to be announced discount window rate cut of 50 bps “allegedly” to bail out Goldman Sachs from some bad positions, markets rallied hard into late August.
That was followed by what many viewed as a dovish speech as highlighted by this New York Times headline on August 31, 2007:
Bernanke Says Fed Is Prepared to Act
The money statement by Federal Reserve Chairman Bernanke from his August 31, 2007 Jackson Hole speech was this small excerpt which created a short term rebound in equity markets:
However, in light of recent financial developments, economic data bearing on past months or quarters may be less useful than usual for our forecasts of economic activity and inflation. Consequently, we will pay particularly close attention to the timeliest indicators, as well as information gleaned from our business and banking contacts around the country. Inevitably, the uncertainty surrounding the outlook will be greater than normal, presenting a challenge to policymakers to manage the risks to their growth and price stability objectives. The Committee continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets.
The divergence between stocks and bonds could not have been clearer and the warning the bond market was sending was crystal clear that the economy was heading for some severely stormy weather ahead.
2025 Another Storm or a Passing Shower?
To reflect on that era is only provide context for what is happening now. The same chart, updated to the past few years, might provide some indications where the long term prospects for the economy might be heading.
So what did Federal Reserve Chair Jay Powell say that was so inspiring to the bulls at Jackson Hole?
Putting the pieces together, what are the implications for monetary policy? In the near term, risks to inflation are tilted to the upside, and risks to employment to the downside—a challenging situation. When our goals are in tension like this, our framework calls for us to balance both sides of our dual mandate. Our policy rate is now 100 basis points closer to neutral than it was a year ago, and the stability of the unemployment rate and other labor market measures allows us to proceed carefully as we consider changes to our policy stance. Nonetheless, with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance.
I have added the emphasis on both Bernanke’s and Powell’s statements for the simple purpose of to compare and contrast.
Short Term Bullishness Might be Warranted
This brings us to the week ahead where short term bullishness and more irrational exuberance might well be warranted. The bond market is acting orderly, rallying in anticipation of a new rate cutting regime from the Fed along with further economic slowing. In fact a glance at the Bank of America/Merrill Lynch MOVE Index reveals relative calm:
This relative calm in the sovereign US credit markets in addition to the apparent willingness to give the FOMC some room to operate this week is why these pages are predicting a 50 bps cut in the Fed Funds Rate this week which will result in a short term burst of bullishness across the board and hell, maybe even a kind Tweet or potty post or whatever they call it on Truth Social from the President.
Unfortunately for the bulls, a small bit of media predicative doom was inserted into the index on August 2nd:
Barron’s record has remained undefeated for decades as they publish super bullish headlines, stories, and of course covers which usually end up in a sharp sudden U-turn then decline in equities and everything else in markets.
Will it happen again?
Conclusion for Cautious Optimism
Thus far, there appears to be ample liquidity, albeit declining, bullish feelings about the economy despite the actual data, and a theory that the lower bound for inflation might implicitly be reset by the Fed in silence to a 3 to 3.5% lower inflation bound based on PCE, not CPI-U; a considerably higher range that the historical stance of the FOMC for the past 20 plus years.
The issue with this bull market is that excessive speculation in parallel with some absurd government trade and economic policies leaves the door open for a trap door to open creating a financial crisis and market crash that the masses could not and will not foresee.
Until that event occurs creating the shock to the entire financial system, I guess it’s “party on Wayne, party on Garth” market conditions for the foreseeable future.
Just be careful about the seasonality issues which still may arise in the next six to eight weeks as America is not in the midst of a rational period of our history.
