The FED just delivered an oversized cut with the S&P500 trading at all-time highs, signalling that, contrary to their mandate, their focus isn’t the economy anymore but to deliver the political agenda of the US Administration in charge. That the FED is now clearly solely focused on defending the stock bubble isn’t something they didn’t try to hide for a long time (“FED AND BOJ WILL DO EVERYTHING THEY CAN THIS WEEK TO SAVE THE STOCKS BUBBLE ONCE AGAIN“) and the latest action simply reaffirms that.
Furthermore, adding this in the context of the latest event, they also signalled the JPY Carry trade unwinding is a serious threat to financial market stability and they are acting to give troubled financial institutions the opportunity to get out of troubled positions, limiting the damages as much as possible (“WHAT IF BANKS ARE COORDINATING WITH THE FED TO LIQUIDATE TENS OF BILLIONS OF TROUBLED JPY CARRY TRADE POSITIONS?“). The question now is: what happens next?
First of all, and this should not come as a surprise to anyone, despite the 50bp cut, we are seeing 10-year yields increasing despite the FED being convinced #inflation will be steadily coming down to their 2% long-term goal. Why? Because this action will obviously flare up inflation that, to all those who live in the real world, is much higher than the bogus data published by the US BLS.
Secondly, the FED is signaling that the financial system cannot sustain the current rate levels anymore, but wary of the reaction and quick escalations that unfolded in the banking crisis last year, this time around they are very careful in disclosing which financial institution is particularly in trouble. T-Bills are warning very loudly about this (“IS THE MARKET PRICING A FED CUT OR IS A NEW BANKING CRISIS ABOUT TO SPARK AGAIN?“) and it is only a matter of time before we see the events unfolding in this direction.
Third, the FED isn’t signalling the economy is strong but the complete opposite. Every time the US Yield curve inverted, it always signaled troubles in the economy with a perfect track record, and this time isn’t different despite their wanting people to believe so (“THE US YIELD CURVE IS SCREAMING “DANGER!” AND ONCE AGAIN NOBODY IS LISTENING“).
So far, stocks are reacting positively because algorithms have been hard-wired to do so and the Central Bank has learned well to play around with them to control market direction. However, the more “humans” start to digest all I described above, the more they will start steering their portfolios towards a safer posture. The speed of this shift will be greatly influenced by the strength of the forced JPY carry trade unwinding, with the risk of triggering another disorderly sell-off especially in Japan if another big “air pocket” is hit in the short term.
In the medium term, the financial institution currently in trouble will have a harder and harder time remaining out of the spotlight. When, like it happened to Credit Suisse, the name starts to make rounds on trading floors, another wave of selling in the stock market will unfold, and this will likely be stronger since coming on top of forced JPY carry trade unwinding.
In the long term, the FED will have to deal with a significantly weakened economy and financial system that will likely scream for another system bailout, but will the FED and the US government be able to provide that given the current level of deficit and FED balance sheet size compared to the past? I don’t think so. This is why I believe today we are seeing the beginning of the end of the great fiat monetary system modern experiment that so obviously failed as similar attempts did before in history.
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