Kid Gloves

We will find out in 2 days whether Powell continues his Volcker Jr. act or he screws up the acting and let's his guard down, revealing his inner dove, which is much closer to what he really thinks.  Psychoanalysis is not my specialty, so I will not dig into that rabbit hole.  But you got a glimpse of how this Fed feels through the writings of WSJ Nick Timiraos, who is undoubtedly in regular contact with the Fed.  Timiraos is the loudspeaker for the micro-managing Fed, who feels like the market is a baby that needs regular coddling and supervision.  After all the resilience this market has shown towards the rate hikes, the Fed still uses kid gloves.  They are afraid that something might break, but at the same time, trying to control inflation expectations with as much forward guidance BS as possible.  

The past 6 months have been an anomaly.  It is not normal, and will be uncommon.  Don't ever forget the default stance of the Fed.  It is to pump up the financial markets.  It is to baby the markets, and err on the dovish side.  High inflation is something that just got in the way of their normal pumping operations.  In no way will they keep fighting inflation if the economy breaks bad.  And so far, the leading indicators have only just begun to creep into corporate earnings and the more coincident indicators.  With a labor shortage, the nonfarm payrolls numbers have been resilient, so it will take time for the employment data to get really bad.  It eventually will get bad, because without heavy fiscal and monetary pumping, you don't have any growth.  But the lagged effect of monetary policy can be stretched out a bit when stocks refuse to go down and stay down.  These counter trend bear market rallies aren't helping with pulling forward weak demand. 

On Sunday, after a furious 1 week rally, Timiraos was on the beat again, talking about how the economy was still strong, with consumer excess savings still high.  That could have been written when 10 year yields were at 4.30%, nothing has changed, but it looks like the Fed gave him a hint to ratchet down the expectations for the upcoming FOMC meeting, as the expectations were starting to get quite dovish and the big rally in stocks isn't what the Fed was looking for.  If they could help it, they would just like to see Treasury bonds go up without stocks going up along with it, but that's not something they can control.  

So the question going into Wednesday is will they try to save the bond market and allow stocks to go wild to the upside along with an easing of financial conditions and inflation expectations?  The RBA, Bank of Canada, and ECB have all responded with less hawkish rhetoric and below expectations rate hikes and/or guidance.  But those regions are either more sensitive to interest rates due to variable rate mortgages or have weaker economies.  Don't forget the US poured the most fiscal and monetary stimulus in 2020 and 2021, and has the one of the stickiest inflation situations among the major economies, so they have more work to do, but are they going to chicken out early?  

Its a tough call, I never like to bet on a Fed being hawkish because their history has shown that they almost always surprise on the dovish side.  If they have a hawkish surprise, its usually well telegraphed.  But I can't imagine Powell liking the reaction in the stock market when he sent whispers to the WSJ to try to save the long bond as it was getting crushed, only resulting in a much bigger rally in stocks rather than the bonds themselves.  With expectations raised for a less hawkish Fed and with a big rally post earnings, it is very possible stocks will be disappointed with what comes out of the FOMC meeting.  But I am cautious about putting on a bigger short position due to the seasonality effects of post-earnings buyback wave + the potential for inflows post FOMC, midterm election, and CPI.  Would have preferred to get out when I had the chance post AMZN earnings bomb, but was a bit too lax on the short position management going into Friday, due to the small position size.  

At the moment, neutral on the bond market, and slightly bearish short term on stocks.  There are no easy opportunities at the moment, hence the light positioning.  The big picture remains as bearish as ever, and the fact that the talking heads on CNBC/Bloomberg are more bullish makes me more confident in my long term view that this bear market has a lot more to go.