Higher Gas Prices & Lower Take Home Pay will Kill Rally

As long as gas prices are pegged to the market rally in equities and the currencies in the Risk On Trade then this rally is nearing its end. Gas prices are up 35 cents and climbing, oil is up $13 and climbing and because of congress consumers are being taxed more in 2013, and as a result have less take home pay to apply towards discretionary spending. That combination makes for a healthy economy? 

Until gasoline and oil finally decouple from the Risk On Trade we are going to continually have this stop and start economy every time the market goes up on the correlated asset trade. At this pace I give the rally two more weeks at most, unless the aforementioned assets decouple. Gold and silver have decoupled, but oil is moving right up with the euro and yen funding currency crosses. 

Since When is a Higher Euro Good for a European Recovery

Not only is the Risk On trade going to kill the market rally in the US as consumers pull back as portrayed by the slide in consumer sentiment yesterday. But a stronger Euro is going to cause a very fragile Europe to contract more making their struggles even more pronounced with uncompetitive exports. This will cause the European market rally to falter, which in turn will cause a selloff in risk assets, and we are right back to where we started begging the central banks for more stimulus to support the markets once again.

The Unintended Consequences

Until markets get this correct, the economy is never going to recover. Essential commodities have to decouple from the risk on trade, especially when supplies are ample in the market. This just taxes consumers more, and they have to pull back discretionary spending to pay for higher fuel costs. Now once Europe and the US pull back, China`s end markets are weaker, and they pull back once again in their manufacturing based economy. 

The Fed Giveth & the Fed Taketh Away

This endless loop is so frustrating because it is easily remedied with some minor tweaks to markets which we have discussed elsewhere. On the policy front the Fed actually got it right with the concentration on mortgages, and QE3 initially didn`t cause oil and gas prices to spike. However, this buying of treasuries once again, just backfires in the long run because any economic gains in the stock market as a result of the extra treasury purchases juicing up stocks also juices up oil prices. Ergo, once oil prices are inflated, this also inflates gasoline prices as we have seen during this run in all Risk On Assets. 

The interconnectedness of markets between the Euro/Dollar cross and the Dollar/Yen cross, equities, oil & gasoline means that the Risk On Trade seals its own demise in the end by being contractionary in nature. 

It is similar to a cocaine addict in the end because the initial increased energy of higher stock prices is overtaken by the negative side effects of higher gas prices and a weakened overall condition after a longer duration of time.

The Einstein Definition of Insanity

So the benefits of higher stock prices are soon negated by higher gasoline prices, which hurts consumers, consumer sentiment, and the economy and this causes the market to sell off, and we are right back to where we started relying on more fed inspired QE programs to stimulate the economy once again. 

It is the dumbest and most self-defeating economic cycle in modern fed theory. The policy has been proven a failure by the very need to be continually “artificially propping up the economy”.