Wall Street legend Marty Zweig is credited with the advice 'don't fight the Fed.' Fed monetary policy tends to drive market direction more than anything else. If you stay bullish when the Fed is dovish and bearish when the Fed is hawkish, then you will generally do quite well.
This is why the current market action is such a puzzle. At the Fed meeting last Wednesday and again on Tuesday, Fed Chair Jerome Powell made it clear that the Fed was still very cautious. There was likely to be a series of additional rate hikes, quantitative tightening would continue, and it would likely take a long-time to hit the 2% inflation target. There is no guarantee that inflation won't rebound or that the Fed can engineer a soft landing.
Despite these cautionary comments, the market has reacted as if the Fed is about to cut interest rates and that there will be only a minor dip in economic growth despite the jump in interest rates over the last year.
So why isn't the market taking Powell more seriously?
Part of the reason is that market participants know that the Fed wants to talk the market down. Fed members want to prevent too much optimism because optimism will lead to higher consumer confidence and more spending, and that causes inflation. It is much easier for Fed policy to work if consumers stop spending and act cautiously.
A second reason the market is ignoring Powell is that many market participants are trading based on flows and positioning. They are ignoring fundamentals and economics and are taking advantage of short squeezes, underinvestment, and manipulation created by short-term options. The seemingly irrational price action feeds on itself and forces even the most rational bears to do some buying.
The primary bullish thesis right now is that we have Goldilocks economic conditions. Inflation is dropping, and there is increased hope that a strong jobs market will help produce a very soft economic landing.
The market seems to go into a frenzy whenever Powell uses the word "disinflation." It is simply an acknowledgment that the goods portion of the economy - which is about 25% - is seeing less inflation. That has been well-known for a while, but the market likes the fact that Powell is referencing it.
In the short term, the best way to deal with this confusing market action is to stay focused on the price action rather than the economic arguments. The bull and bear cases are quite clear, but what is unknown is which will drive the market and create a new trend.
The bulls are winning the argument but have little substantive data to back them up. I'll be watching for potential reversal action, but the bulls are in charge currently.
