Fed Pivot?

Fed Pivot?

The BoJ pivoted with their repeated yen interventions and the BoE intervened to bail out pension funds. Perhaps the Fed isn’t far behind?

It’s true several Fed members have said there is an eventual end to rate hikes, and both the Fed and Treasury have expressed concern about broken markets. That may be encouraging for the bulls, but it sure seems likely that something has to actually break for the Fed to make a substantive change. They’re not just going to do it because it’s Monday, they’re bored, and Cathie Wood wrote them an angry letter. They’ve been clear that they are following their mandate of stable prices and full employment, and nothing there tells them anything about easing off the brakes, whatever investors may want.

So, what would something breaking look like? Well, most likely it would be painful, for starters. The soaring dollar puts great strain on foreign countries. As illustrated by Japan and England, there’s already been quite a bit of stress. The Fed has also quietly been sending dollars to the Swiss National Bank. Unless strains ease from something inside the US, these foreign stresses are likely to continue and worsen.

The laundry list of stress is long. The MOVE index, measuring bond volatility, seems stuck in panic mode, while Treasury bond losses are at historic levels. The corporate bond market has slowed down greatly. UK pension funds, as noted above, have had massive problems and needed to be rescued. With the 60/40 stock/bond model also showing historic losses, is it any stretch to believe there’s potentially big trouble lurking?

In general, if you go from 0% rates towards 5% rates, something will break. There are a lot of zombie companies out there, and while they could survive a long time at 0% rates, at higher rates, they won’t be able to attract more capital or pay interest expense. Trying to solve 14 years of excess in a few months seems like you’re begging for disaster.

I’ve been around long enough to know not to call for a crash. I will, however, say conditions are ripe for significant problems. Bond markets have been showing a significant increase in stress, while the stock market has held up. Long duration bonds and stocks have been highly correlated this year, but as you can see below, that correlation has broken down in the last two weeks. One side of that equation is likely wrong. Considering the stock market has spent the last two weeks playing options games, I suspect I know which side is more likely to be right.

Lastly, prices matter. Considering continued rate hikes, inflation, and QT, the trend is down. Broadly, and I admit I don’t put a great deal of stock in these broad-brush strokes, I’d say as we approach 3,850 in the SPY, I get uninterested in buying the market. As we approach 3,000, the pressure increases to use cash to buy something. We’re on the upper end of that range, so it’s hard to get very excited about broadly buying anything right now. The trend remains down, so it pays to be patient, until something actually changes.

All that can change rapidly, though. Enough trouble could force a Fed pivot at lower prices. Suddenly, we’d have to consider the possibility that we could be looking at a bear market bottom, or at least that other market participants may believe so. It’s quite possible we could see that before the year is out. Right now, anticipating that scenario in positioning seems like an actively bad idea, because there will be pain first. It’s possible, though, that being constructive on the market becomes position A in the weeks and months ahead. We’ll be watching closely.