"While it would be unfair to say that either the Fed or the market is clueless, no one is sure whether we are facing the definitive downswing in the current economic cycle, or another mini-pause."
That's from a short Friday note by SocGen's Kit Juckes, who was weighing in on Paul Tudor Jones's suggestion that stocks should be bought here ahead of the first Fed cut.
The notion that everyone is "clueless" right now isn't a flippant one. Indeed, there's a solid argument to be made that President Trump has deliberately engineered an unprecedented level of uncertainty in order to force the Fed to cut rates. That's the "crazy like a fox" thesis, and in addition to assessing it from all angles on my own site, I penned a Cliffs Notes version for readers here on Thursday.
On Friday, ABC aired additional clips from the network's exclusive interview with Trump. Monetary policy featured prominently in the conversation. Although universally accepted on Wall Street and in market circles, some readers on this platform recently suggested the president is not, in fact, attempting to box Jerome Powell's Fed in. Asked explicitly by George Stephanopoulos whether he was worried he might be putting Powell, quote, "in a box", the president responded as follows:
"Yes, I do. But I’m gonna do it anyway because I’ve waited long enough."
This is an unprecedented situation. Under normal circumstances, this would be a fairly easy scenario to game out. Recent data (e.g., ISM manufacturing, May payrolls, CPI) help make the case for preemptive rate cuts in the face of what, if we're all being honest, is an existential threat to global trade and commerce (i.e., spiraling protectionism).
Sure, there would be some ambiguity around timing (e.g., Does the Fed cut in July or September? How quickly do they follow up with a second cut? Etc.), but given policymakers' professed consternation at persistent undershoots on the inflation front and the clear threat to global growth posed by the trade war, there is a plausible case to be made for so-called "insurance" cuts, despite unemployment parked at a five-decade-nadir. As a quick aside, on Friday, University of Michigan expected change in median prices during the next 5-10 years printed 2.2%. That's a record low and it underscores the idea that consumer expectations for inflation are "catching down" to market expectations, further making the case for Fed cuts and ostensibly validating what, according to BofA's latest FX and rates sentiment survey, is an extreme infatuation with duration.
What makes handicapping the Fed so difficult in this situation is that the very same administration which is orchestrating the trade war is also publicly calling for the Fed to help fight that war. There is no ambiguity here. This week alone, President Trump explicitly linked Fed policy to the trade battle on at least two occasions (once on CNBC with regard to China and again in a tweet about Europe). The problem with that is simple. Even if Powell was predisposed to helping "the cause", the incessant public berating means he can't - or at least not without risking charges of politicization.
It's not clear to me that most investors understand the gravity of this. Simply put: What the Powell Fed decides to do from this point forward is going to shape the future of US monetary policy and could well define the contours of how the most important institution in the world conducts itself under political duress. There is no amorphous Warren Buffett aphorism about ignoring "noise" that works here; no wise, old adage about investing for the long-term and leaving the day-to-day hand-wringing to the "fools" is sufficient to relieve you of the responsibility to pay attention.
Consider the following passage from the latest note by Deutsche Bank's Aleksandar Kocic (who I can confidently say is the most brilliant mind on the sellside):
"The dilemma that defines the current structural instability is the tension between the desire to co-opt monetary policy to complete the markets and the Fed’s resistance towards its exaptation – the effort to drag the Fed into the policy mix and change or augment its role to subsidize the markets subjected to the side-effects of politics. Effectively, the Fed is expected to finance a potential supply of short-term protection (e.g., a lower deductibility S&P put) with long dated (out-of-the-money) put on its credibility; this is a position of increasing liability for them and is logical to expect some kind of contestation."
Assuming the Fed does cut rates, the number of cuts, the language used to explain them and the reaction from politicians will together serve as the source material for one of the most important chapters in the history of the institution.
While this will not be resolved next week, the June FOMC meeting will provide a veritable smorgasbord of information to parse. Everything will be critical, from the statement tweaks to the forward guidance to the dots to the language Powell employs in the press conference.
This meeting comes just days ahead of the G20, where Trump and President Xi Jinping are expected (but no guaranteed) to have a face-to-face discussion on trade. If Powell pre-commits to July (and certainly if the Fed actually pulls the trigger and cuts in June), it gives Trump more leverage, especially in light of the protests in Hong Kong and disappointing April activity out of China, both of which weaken Xi's hand.
If, on the other hand, Powell goes out of his way to walk back market expectations for rate cuts and/or the new dots don't validate market pricing, it will amount to the Fed pushing back against being co-opted into the trade war, potentially undermining Trump's leverage. That's especially true in light of PBoC chief Yi Gang's interview with Bloomberg during which he explicitly said Chinese monetary policy has "tremendous" room to cushion the blow from the trade war.
Deciphering how the market will react under any of these scenarios is the furthest thing from straightforward. It's possible, for instance, that if the Fed leans dovish, Trump will take the opportunity to tip a positive outcome on the trade front in order to give stocks a double dose of rocket fuel (that's the "crazy like a fox" end game). On the other hand, as alluded to above, he could double down on his hardline approach knowing he's got Fed cover.
If the Fed leans hawkish, it could lead to a stock selloff between the June FOMC meeting and the G20, which, depending on the severity, could compel Trump to come away with something positive on trade in order to blunt the market impact of a recalcitrant Fed. On the other hand, Trump could decide to view a hawkish Fed as just another sign that Powell needs more convincing, where "convincing" means doubling (and tripling) down on the trade war in order to cloud the outlook even further.
Here is BofA's attempt to game this out and assign some projections for the S&P (SPY) under various scenarios:
For what it's worth, Goldman continues to believe that the Fed will not cut rates in 2019. Here's a quick excerpt from the bank's June FOMC preview:
"Financial markets and some commentators view rate cuts this year as a foregone conclusion. And while it is a somewhat close call, we expect the Committee will prefer to keep its options open. In our view, not enough has changed to warrant a clear signal of an upcoming cut. In fact, since the March SEP meeting, stock prices are higher, the unemployment rate fell to a 50-year low, consensus growth forecasts are unchanged, and the very tariffs on Mexico that prompted the latest calls for rate cuts have been taken off the table. And outside of May payrolls, the growth data still look decent: our Q2 GDP tracking estimate has rebounded to +1.6%, Atlanta Fed GDPNow is +2.1%, and we are tracking private final demand at an even healthier pace (+2.8%)."
That's all well and good, but, again, the risk is that they (the Fed) fall behind, the trade war escalates quickly and things unravel. There is a point beyond which markets will no longer stomach the trade escalations. Nobody is quite sure what the threshold is, but if you ask Paul Tudor Jones, slapping tariffs on the remainder of Chinese imports may be the straw that finally breaks the camel's back. Here's a quote from the Bloomberg interview mentioned here at the outset:
"I think whether we impose [tariffs on another $300 billion in goods] is going to be very material for whether that’s the tipping point for pushing us into a recession. I think it will have a bigger impact economically than the market thinks."
That sounds dire, but, again, Jones advocates buying stocks right now in anticipation of a Fed cut. Here, for reference, is another chart showing the path of the S&P around "first cuts", so to speak:
As Deutsche's Kocic dryly notes, "there is a clear bifurcating pattern emerging from the figure and the current trajectory does not seem to give a decisive hint of direction." Even if it did (give a decisive hint of direction), it wouldn't matter much because what happens next hinges on the evolution of the most consequential shift in global trade flows since World War II.
If you read the very first linked post above, you'll find SocGen's Juckes pointing out the obvious, which is that the only way it makes sense to pile into equities (or any other risk asset for that matter) right now is if you assume the Fed will succeed in engineering a 1995-style soft landing.
Coming full circle, the problem is that, this time around, engineering a benign outcome entails the Fed tacitly acquiescing to political pressure and thereby compromising its independence. That, in and of itself, could cause a selloff - just ask December, when news that Trump was considering firing Powell added insult to injury for a market that was already in free fall.
Presumably, the combination of a Fed that reverts to a strategy of implicitly protecting risk assets (in Kocic's insurance parlance, "a lower deductibility S&P put") and a concurrent dovish shift among the FOMC's global counterparts, would ensure the viability of a "buy-the-dip" strategy. As the chart below illustrates, that strategy has been more effective than simply buying and holding (out to a five-year horizon anyway) during the post-crisis era.
When you throw in the 1995 analog (which everyone is rolling out right now ahead of expected Fed cuts) and the idea that President Trump won't be inclined to risk a sharp selloff in stocks ahead of an election year, you're inclined to think that SPX > 3,000 is a foregone conclusion.
And yet, as I certainly hope came through in all of the above, such an outcome is anything but preordained. There are so many embedded contingencies here that trying to wrap one's head around them is enough to make one nauseous. It doesn't help that bonds (and the yield curve) seem to be screaming "recession".
Whatever the case, my message to investors here is unequivocal (and, as regular readers are aware, I usually don't deliver unequivocal messages on this platform): For the next six months, you can safely ignore anyone who tells you that long-term investors need not concern themselves with the day-to-day news flow. Right now, you are witnessing a pivotal moment for the Fed. That matters "big league" (to quote the president) for all investors, large, small, long-term, short-term and everything in between.
I'll leave with one final chart which, as Goldman writes, shows that this equity cycle "is still the second longest since 1928 without a bear market, only beaten by the very strong bull market in the 1990s."
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.