A consistent theme in 2023 is that the bulls have relied on positive price action and technicals to squeeze the bears that are mainly focused on the economy and fundamental arguments. There hasn't been a strong or compelling bull thesis, but the market strength causes squeezes and sucks in idle cash from the sidelines. The bulls have been aided by high levels of liquidity, and they are being aided right now, but a huge surge in the Fed balance sheet as funds are made available to shore up banks with liquidity issues.
Price action always wins the battle in the short term, but economics and fundamentals will drive the action in the longer term. The problem for trades is that there just isn't any way to know how far the bulls can run things up in the short term before the big-picture arguments start to matter more.
In January, the price action bulls crushed the bears. The strength was persistent enough to cause many folks to believe that the bear market was over and a new uptrend was developing. The economic bears were forced to cover, but they still insisted that the market was failing to reflect the slow growth that would occur due to high rates and a hawkish Fed.
The bank crisis quickly shifted the narrative in the last two weeks. The crisis was a clear demonstration that high rates were having an economic impact. Federal agencies have moved extremely fast to deal with the issue and restore confidence, but while the fear of a run on books has declined, there is still the issue of valuations and economic impact.
Market players are celebrating the help and protection that central banks and financial agencies around the world are providing. It looks like the crisis is being contained, and there is a rush to try to catch some of the relief rallies.
How long does this celebration and relief rally last?
There is the very consequential Fed interest rate decision on Wednesday. While some high-level strategists predict that the Fed will not raise rates due to the bank crisis, the Fed Fund Futures show that the likelihood of a hike of 0.25% is currently 83.4%.
The primary issue going forward is how much the bank crisis cooled off growth and inflation and how hawkish the Fed will be at subsequent meetings. The market is now expected rate cuts to start at the end of the year, but if there are rate cuts, then the great likelihood is that not only is inflation slowing, but the likelihood of a recession is increasing.
In the big picture, economic bears are confident that the market is mispricing what lies ahead, but the short-term price action bulls are focused on momentum and short-term news flow. The bulls may be wrong about the long term, but they are in control in the short term.