Here we are again… another “make or break” FOMC meeting and JPow speech. Over the past ~6 months of meetings, JPow has been as dovish as possible in the face of clear political pressure (see multiple speeches from both Biden and Yellen on the FOMC cutting rates before year end), contradictory economic and inflation data, an absolute runaway fiscal disaster, and ever loosening financial conditions.
Can JPow afford to maintain the status quo this week? Inflationary pressures have clearly derailed the Committee’s desire for modest rate cuts in 2024 with continuous prints above expectations in both CPI and PCE. Recent FOMC speeches from numerous voting members reflect hesitation to even discuss cuts in the near-term. Commodities are easily the best performing domestic asset YTD (if not globally) across food, energy, and precious metals, which isn’t helping the Fed at all. Employment remains stickier than expected, and high mortgage rates continue to severely restrict the supply side of the housing market, sustaining unaffordably high prices. USD strength in theory can contain further inflation, but it’s clear to me that the multi-trillion US federal fiscal deficits are almost single-handedly exporting inflation across the world – and there’s little the FOMC can do about that. Longer duration UST yields are sitting at YTD highs and not far from last year’s psychologically damaging 5% threshold, exacerbating the budget deficit and making monetary policy even more limp than is accustomed. Google searches for “stagflation” have to be rising…
What’s he to do? A speech like Jackson Hole ~18 months ago – where JPow purportedly ripped up the speech written for him and instead opted for a far more simplistic “inflation is evil and we will win the battle against it” tone – crushed equity markets, sparking a 15% downward move in the S&P 500 before ultimately bottoming in October 2022. I’m not sure he can afford to be that aggressive here, whether that’s because of the pressure it would put on the UST market, or on USD funding in emerging markets and in FX. JPY traded as high as 160 last night before the BOJ intervened, and one would think that a rising USD with UST yields at these levels would trigger some serious funding issues elsewhere. Add in rising volatility and any pressure from 0 DTE puts, and the risk of an accident starts to get uncomfortably high.
At the same time, he can’t afford to exacerbate the “we really want to cut” theme and promote further capital flight to commodities, as it would be self-defeating on the inflation front. At this point in the cycle, those capital flows to commodities are inevitable, both domestically and globally (and not just for purely economic reasons), but encouraging asset flows to commodities would be equivalent to proverbially spitting on the face of the very people he’s said he’s focusing on protecting – the American public.
He has a very fine line to walk, and one that is increasingly getting so thin we won’t be able to see it much longer. Quite simply, US federal budget deficits are pushing us increasingly toward a new monetary regime that the FOMC is powerless to stop. He’s just trying to buy as much time as possible, and pushing on a string only works so well.
Across asset markets, charts are showing the similarly material inflection point.
- Gold has formed consecutive bear flag patterns in the context of a broader bull flag, all while trying to hang on to its 20 day moving average. In all likelihood, this means a sizable move is coming – my guess is $100+ in either direction in the next week to 10 days. Technically these patterns don’t often resolve themselves quietly, and i don’t think this time will be different.
- 30 year UST yields are at highs for the year and have blown through every Fibonacci support level I’ve highlighted except the 76% at 4.88%. The YTD channel higher has been respected and I expect it will hold, but this is not a chart that will make Janet happy… Treasury’s QRA announcement is Wednesday morning (ironically ahead of FOMC), note that the QRA in October last year was arguably as responsible for igniting the massive rally last year as anything. Not sure we’ll get the same effect this week, just something to be aware of.
- DXY has been a beast lately, again respecting trend channels and building a bull flag on the daily chart. This needs to abate for any sustainable rally in assets to occur, but it looks like it wants to make a higher high towards 107-108.
- Pretty certain S&P 500 sees new highs before the end of the year, but the move from here in the next few weeks is equally binary – straight up to new highs (~200 points) or (more likely) down to 46xx or 48xx. Decision zone this week is somewhere between 5120 and 5150, with any number of potential catalysts: AAPL/AMZN earnings, FOMC, labor data, QRA, PMIs, FX intervention (e.g. JPY last night). The 200 day MA sits at ~4700 currently and is a very logical support zone if we get there.
I think JPow needs an excuse to get dovish again, and he has the ability to almost manufacture that excuse in the coming weeks. With fiscal spending completely out of control, along with UST yields and inflation, he knows we’re not far from restarting some iteration of QE (my guess is it’s more likely to be a tweak of the SLR rules with banks than outright monetization), but he can’t do that unless/until he gets some serious asset and/or economic pressure.
My expectation is a swift move down in assets in the coming weeks on USD strength, an increase in the severity of the inverted UST yield curve, and some form of “event” the creates some panic in assets and a bit of a capitulatory move. If we do indeed get that, the opportunities on the back end should be mind numbingly boring and yet incredibly profitable through the summer months – outright longs of commodities, utilities, longer duration USTs (both carry and principal appreciation), and call overwriting strategies, all while being tactically short USD.
Supporting charts below, hopefully this ages well… have a great week.
