Monetary Policy Fuel Effects

Macro Perspectives

The fall in gas prices in July was telegraphing a cooler inflation number coming into yesterday’s CPI report - that's indeed what we got.

We discussed yesterday, given Jerome Powell's most recent statement that the Fed had reached a neutral level on the Fed Funds rate, a softer inflation number would be a green light for stocks - it was.

Let's take a look at the S&P 500 chart.

Stocks closed yesterday on the highs, breaking the June highs, and now trading 16% off of the lows of just two months ago. 

Keep in mind, this decline of the first half, and the trajectory going forward for stocks (and investable asset prices), has everything to do with monetary policy (central banks). The central banks (led by the Fed) threatened to crush inflation with high rates. Stocks went down . . . They were bluffing . . . And now, the market is pricing in the near end of tightening (if not the end) . . .

With that in mind, what marked the low for stocks in June? Central banks.

That June low (chart above) came as the Fed, Swiss National Bank, Australia, the Bank of England and Canada all raised rates and talked tough. Meanwhile, as we discussed in my 17 June note (click here), the biggest central banks in the world were responding to an average inflation across these countries of 6%, with an average central bank benchmark rate of just +0.6%.

It looked like all talk, little action.

The tell-tale sign came the next day. There was speculation that the Bank of Japan might begin to exit QE and emergency policies, as inflation has been reaching levels only seen a few times in the past forty years. They didn't. They doubled down - on being a (continued) unlimited buyer of assets (domestic and global).

This was a clue (if not proof) that the global financial system can't withstand the removal of liquidity. The Bank of Japan had to stand pat, as a provider of global liquidity (they had to keep printing).

Also, very importantly, despite talking tough about rates too, the ECB, just days earlier, had an emergency meeting where they determined a new plan (same as the old) to buy government bonds of the fiscally weaker eurozone countries - they ended QE, and then created a new plan to restart it.

The confluence of these central banks events was the bottom for stocks. And as you can also see in the chart above, the bullish break of the down trend in the S&P 500 (the world's proxy for broad stocks), came with another central bank moment. It came on the day of this past Fed meeting, after Jerome Powell said they had reached the neutral level for interest rates (neither accommodative, nor restrictive to economic activity).

This all supports the point I've made all along: QE is like Hotel California, "You can check out, but you can never leave." And after governments ballooned global sovereign debt over the past fourteen years, amplified by the post-covid response, low rates also appear to be a "never leave" scenario. The markets seem to have come around to that conclusion.

Bottom line: The monetary policy fuel for stocks doesn't seem to be going away.

What will be the ultimate relief valve for this continued unsustainable path? The currency (a devaluation). With that, let's take a look at the dollar...

The dollar broke the uptrend yesterday. But this is more about paper currencies relative to real assets. A lower dollar, means the resumption of higher prices in real assets (particularly commodities).

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