At the start of this year, everyone was obsessed with inflation, and rightly so. But now, it's all about growth.
Or a lack there of.
We all know the Fed has been on an aggressive campaign to lower the pace of price increases, no matter the cost. After boosting the markets with trillions of dollars' worth of liquidity during Covid, the Fed felt it could not risk inflation surpassing its target of 2%. If so, the Fed feared it would lose control of prices altogether.
So it embarked on one of most significant rate-rising campaigns in the history of financial markets, which caused havoc in the bond markets and yield curves. The blowout of yield differentials ran over the U.S. regional banks -- until they had to yet again get saved by the federal government. This constant battle of throwing money at the system on one side and then taking it out from the other, is why the market has been range-bound from an index point of view. What is happening underneath the surface is even more incredible.
The latest consumer price index report landed 0.1% lower across the board led to cheer, as the market is convinced the Fed is finished raising rates, with just one more quarter-point hike to come. Investors seem to be looking at the glass-half-full scenario now. But what is not being priced in is how much and how effective these hikes have been so far. It takes about 6-8 months before the rate hikes actually impact the economy. It is like steering a big ship, when you move it initially, you get no reaction, but then you must wait before steering again, as there is a time lag. If you steer it too much too soon, waiting for a quicker reaction, you'll have trouble. It will be too late and by the time the ship is turned, it will have gone way off the mark. That is what is happening to the markets today, the Fed plays a backward-looking role in its monetary policy, by the time it reacts, it is often too late. But can we blame the Fed? The labor market has indeed held up well and good prices -- along with services prices -- are falling with no hiccup in the economy. The Fed is convinced its strategy is working without any repercussions. But then again, when did they ever get it right?
The slowdown is real. We may argue whether there is a recession, but technically we are already in one. Don't believe me? Look at the industrial slowdown, the global Purchasing Managers' Index numbers falling, Institute for Supply Management weakness, the retail sales slowdown and the fragile demand picture. All this shows real weakness in the consumer. People had been shielded by the fiscal policy and Covid stimulus measures -- added to excess savings and maxing out on credit cards. It takes a while for these things to play out. But at a time when U.S. debt to GDP is at its heights and when rates are at their highest in decades, can we really assume the system will be able to get past all this without a hitch? Going back to 2007, it took the market a good 15 months before we saw the real impact of just how tight the system was.
All the bullish hopes for a second half of 2023 rebound rest upon China stimulating its way out of its slump. China's latest numbers signal a deflationary pulse. It has a huge balance sheet issue whereby it cannot keep printing money. The issue is not just the domestic consumer, but also, the export weakness. Despite calls from all the sell-side houses, some still talking oil north of $100 per barrel, demand remains weak and supply is ample. This is evident in freight, shipping, and a host of other indicators. The bond market has been signalling this for months, but retail investors are too busy chasing the likes of Apple (AAPL) , Nvidia (NVDA) , and large cap Top 7 names, which have accounted for more than 80% of the year-to-date return in the S&P 500. True, their cash flows look impressive, but if times get too tough, will they be able to weather the storm? The bond market has been at the opposite side of equity markets over the past few months. But, then, we all know which one usually tends to be right....
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