The Fed Crying Has Begun

Authored by Sven Henrich via NorthmanTrader.com,

So stocks dropped a little in October. Ok they actually dropped a lot and all of a sudden the S&P 500 was miles away from the all those optimistic 3,000+ year end targets. And what happens when stocks drop hard? Bulls cry for the Fed to come to the rescue.

It was quite the scene.

Here’s the global market cap wiped off in just October:

$8 TRILLION. Poof. Gone. The largest drop since 2008.

So it is no wonder the Fed begging has begun. From the president on down:

Jim Cramer: 

“My main fear is that we could have a mini version of 2008 if the Fed doesn’t change course,” the “Mad Money” host said. “Our one hope? If Fed chief Jerome Powell actually starts listening to the stock market and wakes up to the damage that tariffs can do to the economy, then maybe he’ll shift gears, just like Greenspan did in ’98. Then we can bottom and even roar higher. But as long as Powell stays committed to the December hike and three more next year, … and the president stays committed to expanding his tariffs, then history says we’ve got more downside no matter what.”

Canaccord’s Tony Dwyer: 

“Fed needs to take its foot off the throat of the market.”

Bill Stone Avalon Advisors’ co-chief investment officer:

 “The one thing to watch is the Fed, the market is looking at the possibility of a policy error there — that they’ll tighten too hard.”

Merrill Lynch’s head of market strategy Joe Quinlan:

 “The current market rally has legs, as long as a hawkish Fed doesn’t stop it”

From the Financial Times:

“The market turmoil of the past month threatens to put the brakes on US economic growth, according to a closely watched measure of financial conditions. Conditions have tightened so sharply in recent weeks, investors are beginning to suggest that the Federal Reserve could limit the number of times it raises interest rates. The S&P 500 has tumbled over 8 per cent since the start of October — on course for its worst monthly performance since February 2009 — raising equity funding costs for companies and sending the Goldman Sachs’ financial conditions index to its highest level since April 2017. Measures of financial conditions typically factor in long-term bond yields, corporate borrowing rates, currency fluctuations and share prices, and assess how supportive or restrictive they are for the economy. Ian Lyngen, head of US rates strategy at BMO Capital Markets, said that investors were “getting nervous that the sell-off has tightened financial conditions enough that the Fed will struggle to achieve some of its policy goals, such as raising interest rates to their ideal target level.”

You get my drift: Basically everyone is now setting up the argument that it’s the Fed’s fault if markets can’t advance. Really? After 10 years of straight up years (courtesy easy central bank money) at the first sign of the 10 year yield at risk of breaking out above trend everyone wants the Fed to stop.

Please. What’s the argument here, the Fed is hiking too aggressively?

It’s just not true.

If anything the Fed has slow walked this rate hike cycle compared to previous rate hike cycles. Everyone wants the Fed to stop raising rates here?

Here? Give me a break. At a point where real rates remain negative, the effective Fed funds rate is barely above 2% and we just saw the slowest rate hike cycle in decades. Please.

If the debt construct is so sensitive that it can’t even handle a little attempt at normalization then this entire experiment has been a giant failure.

And maybe that’s what everyone is worried about.

Growth has been slowing down globally with negative rates and intervention still being on the daily market menu in many places.

Look at the data coming in:

South Korea:

Japan:

China:

Europe:

Slowing growth with rising inflation:

A winning combination if I ever saw one. 

And the US? You tell me.

Capex spending growth? I don’t see it:

GDP already slowed from the Q2 4.2% sugar high to a lower 3.5%, a print heavily relying heavily on government expenditures and an increasing in inventory build:

Massive debt is the name of the game and we just saw how fear of rising rates contributed to markets selling off.

Debt serviceability matters and the US stands out:

And with tax cuts and increased military spending the US is going pedal to the metal on debt expansion:

And corporations are on the same page:

High yield default rates are still not showing signs of stress, but compared to the size of the underlying economy corporate debt has never been higher.

As rates are rising the very real cost of servicing this debt via interest payments is very evident:

It’s not a mystery. Decades of expanding debt, enabled by artificial low rates are now running into a wall of serviceability, particularly as the US government needs for more debt financing has accelerated courtesy tax cut.

This chart is going to $30 trillion+:

Best of luck:

So no wonder all of sudden participants are freaking out about the Fed continuing to raise rates. The Fed needs ammunition for the next recession, but, because they slow walked it all, they let markets run into its next bubble and now the hangover has begun.

And instead of aggressively raising (as they have in the past cycles) when they had the chance they are now set up to be the fall guy. Serves them right.

They kept kicking the can, always cautious, always uncertain, always tinkering. Well now things have gotten shaky and major trends are at risk and they have preciously less ammunition compared to previous slowdowns.

And so here we are (see also: Back With a Vengeance, BUT):

Key trend line confluence between markets and the 10 year yield.

If the Fed caves and slows down its rate hike cycle bulls can find comfort in a dovish Fed again.

If the Fed sticks to its guns for once and trend lines break everybody can blame the Fed. I can hear them already now: “Wasn’t our fault for running investors off the cliff again. It’s the Fed’s fault”.

Right.

Or maybe the truth is a lot more sinister and that is that the Fed’s playing a losing hand. With each boom and bust cycle they are forced to lower rates ever lower and can raise them only to ever lower highs, a cycle that will ultimately result in failure.

Why? Because while the Fed responds to recessions with easy money (lowering rates) while our political system is unable to solve structural problems and hence the answer has been ever more debt and the Fed enabled this spiral with cheap money:

And so when markets eventually break their trends the Fed will be forced to lower rates again.

Fed chair Powell is not in enviable position here.

  • If he doesn’t raise rates in December the Fed’s independence will be questioned having been perceived to have succumbed to political pressure and perhaps admitting that the market construct can’t handle higher rates. In that case the reaction may be ultimately opposite of what everyone expects. While the Fed caving may bring about a year end rally it could also badly damage confidence going into 2019.

  • If Powell does raise rates and markets freak and break their 2009 trends the ensuing market calamity may force the Fed to cut rates again in 2019.

The Fed crying has already begun. Let’s see how it ends. Don’t be surprised to see more tears. A lot more tears.

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