Market Lab Report - Why the Fed will have to keep printing; Do markets have to retest lows?

by Dr. Chris Kacher

Why the Fed will have to keep printing

Currently, the 10-Year Treasury Yield is currently at 2.89% (as of this writing).



That the yield fell since mid-June suggests the market thinks Powell may pivot sooner than later by halting hikes given that inflation came in 0.2% under expectations across the board for both CPI and core CPI, but the CPI still remains at levels well above the Fed's target rate of 2%. PPI also came in under expectations while energy nosedived after spiking higher in prior months. Nominal wages are up but when adjusted for inflation, wages actually fell so are unable to keep pace with inflation. Indeed, the recession is likely to be deeper than typical recessions.


Lower oil and the soaring sales/inventory ratio suggests inflation could fall further enabling Powell to temper the pace of hikes. But heating oil is scarce so the price of oil could start into a new uptrend. Nevertheless commodity prices appear to be moderating. Given all of this, CME Fed Futures is no longer pricing in 75 bps but a 50 bps rate hike in both September and November then a 25 bps rate hike in December which would bring the FFR to 325-350.

But rates may not get there because the US Debt Clock shows the interest paid on the record levels of debt could exceed the US federal tax revenue if rates went beyond 325-350. This is why the Fed has painted itself into a tight corner and will inevitably have to continue to print. This is also why M2 never materially drops once debt reaches such levels if hundreds of years of history are any guide.


Majors to retest lows when?

Major stock market averages should start into a major downtrend should rates exceed 325-350, pushing Powell to replay what happened in Dec-2018 when we had the first xmas crash on record. Powell then immediately told the markets he would stop tightening the balance sheet. That was the major low for both stock and crypto markets.

Given that major averages now have "cushion" having rallied since June, Powell now has room to hike until the majors retest and plumb new lows. Markets may allow him to hike until December before they capitulate. Given the record levels of debt, it is unlikely they will allow rate hikes beyond an FFR of 325-350 as delinquencies are moving higher once again so could accelerate. Once rates exceed 325-350, this could create serious issues for debtors.
 
One way out

One scenario against the major averages retesting then plumbing to new lows is if CPI and core inflation continues to fall due to the factors mentioned above while the recession shows itself to be more serious than a typical recession. This could push Powell into halting the hikes altogether which would likely signal a major low if markets capitulated, otherwise markets could shift into a sideways, lackluster bull as they did in 2016 when rate hikes were halted all year. That markets have rallied off lows suggests they are pricing in this possibility. But given high inflation, they will have to hike. It is just a question of how much- 50 or 75 bps in September? 25 or 50 bps in November? Powell has said this is data dependent.

Globally, while the Bank of England is anticipating inflation to continue higher until the end of the year, thus hiked by 50 bps which was the largest rate hike since 1995. China's economy is in trouble. Singularly, China just announce a surprise rate cut. Though China beats to its own drum, we could be only a few months away from the start of a global trend toward lowering interest rates which could mark major lows for cryptocurrencies since they remain highly correlated to the printing of money.