Fed Halt Now Baked into the Cake

Yesterday’s moonshot was a marvelous thing to behold. The market took off on soft PPI and housing data, lit the second stage boosters on Janet Yellen’s dovish comments, and then kicked in the afterburners on the Fed minutes.

Still, these one day wonders have not been long lasting over the past few years. The rally on Tuesday smacked of panic buying, with shorts scrambling to cover and longs pressing their bets. It was not what one would call a day of quiet contemplation on Wall Street. Panic — in either buying or selling — is rarely rewarded in the markets.

Yesterday’s gains brought most indices back over their first week highs, with the NDX and the Dow Utilities as the notable exceptions.

The net net results are twofold: First, the market has (once again) priced in the end of the tightening cycle. This is now the fourth such rally based on the "end" of the Fed Cycle. Each of the prior "One & Done" rallies have failed, as the Fed has continued to tighten.

Second, the good news is now mostly baked into the cake. This now sets up Markets for two potentially disappointing scenarios:  One, the Fed doesn’t stop at 5% (watch the June FOMC meeting). Two, the Fed pauses — but being "data dependent," is then forced to resume tightening by the continued broad price rises driven by Chinese demand and excess global liquidity.

I view this Pause/Resume scenario as the most perilous for the markets. It paints Bernanke (so much for muscularity) as a dovish appeaser of equity markets. Even worse, it will give the markets paroxysms. The most damaging Pause/Resume situation that occurs is more commodity driven inflation forcing the Fed’s hand, while higher energy prices and slowing real estate pinch the consumer.

Finally, it is quite revealing how atypically dependent this economy and market actually are on government stimulus:  Money supply increases, deficit spending, tax cuts, and of course, ultra low interest rates are the drivers here — not organic growth.

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As we have discussed previously, in the past the last Fed hike has not been a market friendly event — I’ll have more on this later. Its a classic issue of confusing causation with correlation. Everyone likes low interest rates, and associates that with stimulus. But the end of the rate hiking cycle will occur when the Fed sees the expansion phase of the economy ending. And in most cases, when economic expansion ends, often Bull Markets do too.

Stay tuned . . .

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