Repeating Lies

"If you tell a lie big enough and keep repeating it, people will eventually come to believe it."  - Joseph Goebbels, Nazi propagandist

Lies = Fed forward guidance.  The Fed is as united as they have ever been.  Its almost as if they met and said, "hey, we've got to talk hawkish to get inflation expectations down and financial conditions tighter, no matter what."  And they've repeated their hawkish rhetoric, all of them, over and over again, to the point that investors who are losing money are getting sick of hearing it.  For the few weeks where they backed off of forward guidance in the middle of the summer, they soon realized how insignificant they felt, how the market was going where it thought it should go (higher stocks and bonds), and they didn't like it.  So they went right back to doing forward guidance, but this time all in synchrony and on full blast.  

The Fed's forward guidance has such a terrible track record, that its puzzling to see the Fed governors complain about the STIRs market pricing in a rate cut in 2023, contrary to forward guidance for no cuts in 2023.  Frankly, I'm surprised the STIRs market is pricing in just one 25 bps rate cut for 2023, because the Fed has a history for terrible predictions about future policy, and they've tended to cut fast and big when they see the economy getting very weak.  And most signs are pointing to a very weak economy in 2023.

The Fed is fighting the bond market, and its winning, for now.  Whenever the curve is inverted this much, its because Fed policy is too tight.  But the bond market is an arbiter of truth (as long as the central banks don't do QE), and will eventually break the shackles of Fed forward guidance when the recessionary evidence starts mounting.  And it is starting to add up.  The weak ISM number last week, the big drop in job openings, and the various earnings warnings over the past few weeks.  There is a global recession happening, but the data that the Fed watches lags, so the Fed has cover to talk a hawkish game.  But not for long. 

All that consumer spending on goods in 2020 and 2021 means many pulled forward their purchases with the help of fiscal stimulus.  That fiscal stimulus is mostly gone, there is still a bit here and there, gas stimmies, electricity bill stimmies, etc, but those are minor compared to the big bazooka in 2020 and 2021.  Inflation has also done a good job of eating into consumers' purchasing power and excess savings, reducing demand.  M2 money supply growth is barely positive for 2022, which is a huge break from trend, when its averaged around 7-8% annually since 2000.   M2 supply growth feeds to inflation with a 12-18 month lag. 

With limited fiscal stimulus in 2022, and likely to be limited new fiscal stimulus in 2023 and 2024 with Washington gridlock, the biggest driver of inflation, excessive fiscal spending/tax cuts, will be absent.  Add to that, a Chinese economy that will be dealing with the popping of a huge property bubble and Europe that will be dealing with high electricity prices for the next few years (reducing discretionary spending), and you have the ingredients for a disinflationary wave.  Very few people are talking about this possibility.  Almost all I hear from the 5 minute macro experts is secular inflation, energy and commodity inflation due to supply concerns, a tight labor market, stagflation, etc.  I hear very few talk about a disinflationary cycle that lasts until 2024, due to the lack of a big fiscal stimulus wave and low population growth in the developed economies and China.  

The dirty little secret about inflation is that fiscal policy is more important than monetary policy in determining the inflation rate.  Powell can try to be Volcker Jr. as much as he wants, if the White House and Capitol Hill go on a deficit spending binge, inflation will go up, even with higher rates.  Just look at Argentina.  Last I checked, their interest rates were at 75% and their inflation is out of control.  In fact, over the long run, it can be argued that if you keep rates high, the interest income that flows from the Treasury to bond investors is a stimulus paid for by higher deficits. 

It is interesting that there are more people trying to play for a technical bounce in stocks than in bonds, even though the main catalyst for a bounce would be weaker economic data / lower inflation numbers, which usually benefits bonds more than stocks.  Really the only fundamental reason for buying stocks is to play for a Fed pivot based on peak hawkishness.  All of the leading indicators are showing earnings going down bigly in the next few quarters, so earnings will be a drag on stocks.  And valuations are still too high considering the higher risk free rate and dropping forward earnings estimates. On a pure valuation basis, stocks are expensive to bonds, but there have been more inflows into stocks than bond funds in 2022. 

There is a lot of talk about the Fed pivot, but there is no clear definition of it.  Its generally accepted that the Fed is a long ways from pivoting, or at least there needs to be a few weaker than expected CPI reports and nonfarm payroll numbers.  Unlike what most investors think at the moment, the bar has actually been lowered for a Fed pivot because the Fed funds rate is already 3-3.25%.  If the Fed funds rate was 1-1.25%, even some things breaking wouldn't get the Fed to pivot.  But at a Fed funds rate of over 4% by year end, which is almost guaranteed, it won't take much for the Fed to start talking less hawkish or gasp, even a bit dovish.  And I expect the economic data will start coming in much weaker which will also make it easier for the Fed to take their foot off the brake and stop and assess the damage. 

Covered the remaining shorts yesterday and now just long some Treasuries.  Don't want any short exposure going into the CPI number on Thursday, as I think a lot of the selling since Friday has been investor positioning ahead of the CPI.  This is a very different situation than before the CPI in September.  The SPX is down over 500 points from pre CPI levels in Sep., and bond yields are also much higher.   The hurdle to get the market to selloff on a hot CPI is much higher.  Neutral on stocks at the moment, but a bounce later in the week wouldn't surprise me.