Thursday, June 14, 2018

Hawkish Powell Dovish Draghi

Jerome Powell is drinking the kool aid.  Unlike the March meeting, he literally was foaming at the mouth about the US economy, about as excited as you will see a central banker in front a crowd.  It is almost as if ordered by Trump, gushing about the economy and jobs and to keep the bond vigilantes at bay, stating that inflation remains moderate.

I will admit that Powell was given a raw deal, being handed the keys to a late cycle economy with the Fed funds rate at 1.25-1.50%.  It was Bernanke and Yellen who nurtured this bubble, with their needless QEs, taper delays, rate hike delays, and turtle like speed in raising rates.  Bernanke should have been the one who should have started the rate hiking cycle, not Yellen.  He was the clown who insisted on QE2 and QE3 when it was totally unnecessary.  QE3 and its taper effectively delayed rate hikes by 2 years.  QE3 was started in September 2012 and continued until December 2014, when the taper finally ended.  When it was clear that the US economy was growing strongly in 2013 post fiscal cliff, he should have put in the first rate hike in the second half of that year. 2014 should have had at least 4 rate hikes.

The bond market was having a taper tantrum for a reason in 2013.  It realized that there was nobody keeping the insane clown posse of speculators under control.  Bernanke was the chief clown himself.  Only an imminent QE by the ECB was able to keep bond yields in check.

Yellen was almost as bad as Bernanke, which is saying a lot.  She instituted a painfully slow QE taper as the SPX kept making new highs and the US economy was at its strongest (2014) over the past 10 years.  And then in 2015, when interest rates should have been hiked immediately after the taper was over, she waited till the final days of 2015 to put in a token rate hike to try to maintain its last remaining ounce of credibility, which was mostly frittered away by Bernanke's bubble blowing ways.  So when 2016 slowdown happened, the Fed couldn't do anything, because the Fed funds rate was 25 -50 bps, when it should have been 225-250 bps.  In that case, the Fed probably could have cut rates a few times and probably would have resulted in a stronger economy in 2016.  Only after the S&P made an all time high AND Trump got elected with promises for huge tax cuts, did Yellen finally do another rate hike.  It took an almost perfectly placid uptrending stock market in 2017 to get her to do 3 rate hikes that year.  Just really bad.

So yeah, Powell is better than both of them, by a mile, but its too little too late.  Bernanke and Yellen basically took a page out of Greenspan, doing an even worse job of delaying rate hikes for way too long, and set up this scenario where Powell will be blamed for the next bear market in stocks because they got too high and overvalued under Bernanke and Yellen.

Here is what is going on in the big picture.  The US economy is clearly in the late cycle phase, and much of the fiscal stimulus is being negated by higher interest rates and a slowing Europe and emerging markets.  Stocks are grinding higher on animal spirits and stock buybacks coming from repatriation, not better fundamentals.  In the meantime, there are plenty of signs that Europe is back to its old, moribund economy, and China's financial system is being held together with duct tape handed out by the PBOC.

Draghi senses that Europe's growth has peaked and had to throw the European markets a dove bone with a 1 year promise of no rate hikes with his QE taper ending in December.  He wants a lower euro, and he needs a lower euro.  He got the job done today with his forward rate guidance.  But he just used up one of his bullets that he may need when Europe is in even worse shape.  He really can't do any more rate cuts because rates are already deeply negative, and because of a shortage of Bunds, he can't go back to QE unless he changes the capital key rules for bond purchases.  That leaves just the nuclear option of buying European equities, which will probably only be brought out when Europe is about to enter recession.

We are getting a BTFD gap up off a dovish Draghi, even though the US multinationals will have to deal with a stronger dollar because of it.  Its been a strong uptrend over the last 6 weeks, so its probably not going to end immediately, but Powell's hawkishness will probably keep a ceiling on the SPX around 2800.  A hawkish Powell only strengthens my conviction that the SPX will drop in the coming months.  He seems intent on hiking until something really bad happens, which makes the probability of something bad happening much higher.  Have my hand on the sell SPX trigger, ready to pull any day now, but trying to be patient so I don't short early.


Gipper said...

I'm curious, when this bear arrives, how long do you foresee it lasting?

Market Owl said...

I think it lasts at least 1 year. This is going be shorter than 2000-2002, probably about as long as 2007-2009. Should finish the bear market around SPX 1900-2000.

Gipper said...

Interesting.Thank-you. I always value your insight.