"Whatever It Takes"

CLUB/EDGE client post Sunday, August 25, 2024. Focus on JACKSON HOLE, the death of #HFL, and my checklist for Global Leverage Unwind.

» CLUB/EDGE client post AUGUST 25th, 5:53 PM.

In reminiscence of Draghi's “whatever it takes” speech from July 2012, when then ECB President Mario Draghi said what he had to in order to turnaround the European sovereign debt crisis, Powell on Friday at Jackson Hole struck a similar chord in my ears.

From Nick Timiraos and his WSJ article:

The Powell pivot is complete.
Powell is dovish across the board—from the same stage where he two years ago signaled the Fed would accept a recession as the price of restoring inflation:

“The cooling in labor market conditions is unmistakable.”
“It seems unlikely that the labor market will be a source of elevated inflationary pressures anytime soon.”
“We do not seek or welcome further cooling in labor market conditions.”
“The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”
“We will do everything we can to support a strong labor market as we make further progress toward price stability.”

Bolded emphasis above is mine - because I want to highlight a few key themes I see:

1. THIS IS A PIVOT. It's a double pivot actually: the end of a rate-hiking AND rate-pausing regime. Carry traders, in particular, can hitch their wagon to a monetary path that is clear, but once it is announced that it will end, they must unwind/reposition for the next macro trend. Is it a wonder Fed is talking "normalization" versus "accommodative" cut? The more gradual the rate cuts; the more gradual the unwind. Let's see how well they do to land this plane - especially since they are politically and self-motivated to not crash before the November 5th election.

2. Powell eviscerated #HigherForLonger. Inflationary fiscal spending meet Fed balance sheet tightening. Structural inflation meet monetary deflation. This - “falling credit demand, rising UE, earnings as good as it gets, and the narrative turning from inflation to deflation” - is exactly what I discussed with @JasonEBurack two months ago on his podcast: https://t.co/ysnrPfzvFN https://t.co/fCcmWjraQw!!

3. Fed is (once again) "data dependent". Ah, this language matters for several reasons. Frist, they have pivoted to focus squarely on labor not inflation this time. This means they are WORRIED about jobs and wages not inflation. This means the carry trades will be WORRIED about jobs and wages not inflation. So the market timers like me who are worried about “falling credit demand, rising UE, earnings as good as it gets, and the narrative turning from inflation to deflation”... will obsess over the health and direction of private payrolls, the obfuscation of BLS data revisions, the crowding out of government spending that inflates wages all while laser-focused on wage trends (as predictive recession indicator) relative to consumer spending trends (which makes up 70% of GDP).

Many were surprised how dovish Powell turned - as they gaze at markets 1% from all-time-highs and "fear of recession" is loudly attacked by media and macro gurus as far as my twitter-verse can travel. But I am not surprised!!

I have warned since early May,

"What if yields crash down not up?"

And early June for my Bloomberg interview,

"Bond market may be growing worried that Global Credit Demand is falling from too-high and higher-for-longer rates so global rate cuts are an economic necessity not political luxury."

Then early July I warned loudly to hedge just before NDX crashed 15%, SOX 25% and NVDA 35% into August 5th on risk of 'CONCENTRATION RISK UNWIND',

"If yields do drop below 4.2% what does that say about economic slowdown, and the cuts being pulled forward means we have global credit demand falling and that will start to pull forward recession risk and make the whole self-fulfilling prophecy of further growth slowdown."

I was on the other side of #HFL since early May & I am on the other side of #SoftLanding since early July.

I expect a bear market into H2 2024 & 2025 caused by falling global credit demand, larger-than-expected rate cuts, a slowing U.S. economy with higher unemployment, not to mention lower oil prices and crashing lower yields.

Add to that, I still think election risk is underpriced and NVDA, Bitcoin and AI are grossly overvalued.

Global Leverage Unwind

My world view:

1. Global credit demand falls
2. Inflation falls
3. Rates fall
4. Demand falls
5. Jobs fall
6. Oil price falls
7. Stocks fall
8. Wage growth falls
9. Fed cuts aggressively
10. Recession

By my estimates, we are almost half-way there...to that place just AFTER recession risk is priced so far out that it is unimaginable and right BEFORE it starts to get real.

Add to that, Policy Intervention & QE have diminishing rates of return, especially when falling inflation triggers carry trade unwinds, which are triggered by Central Banks unable to inflate debt away, which is reason funds can stay short notes/bonds and oil or long big tech in the first place!

This all changes if "whatever it takes" isn't enough to keep my Three Main Recession Tells from triggering:

WHEN THE 10 YEAR GETS/STAYS BELOW 3.8%…
Carry trades unwind again.

WHEN THE 10 YEAR GETS/STAYS BELOW 3.8%…
AND CRUDE OIL GETS/STAYS BELOW $70…
Carry trades unwind in a bigger way.

WHEN THE 10 YEAR GETS/STAYS BELOW 3.8%…
AND CRUDE GETS/STAYS BELOW $70…
AND JOBLESS CLAIMS GET/STAY ABOVE 267K…
Carry trades will price in recession because they will force one.

So as long as these triggers are avoided, we can keep rallying!

But, a market correction on global leverage unwinding ...will negatively impact liquidity and credit spreads; the wealth effect + govt tax receipts; company margins + employment, yada yada.

Irony: Just as equity markets price in Fed easing because inflation is under control - with little fear of recession or deflation - is exactly when you need to guard against it.