The Fed: Drumbeats of Recession Grow Louder
Beneath the surface of an extraordinarily bullish FEDeral Government Put that is likely to drive SPX up to 6000 by Election Day, the Fed is laying the groundwork for a recession in '25.
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Discussion
The Powell Pivot did not come last December 13 when he put rate cuts squarely on the table, as many posit, it came at the November 1 FOMC when the Fed shifted from targeting “below trend growth” to “below potential growth” in order to bring inflation durably back to 2%. In short, the Fed saw rapid disinflation and started to count their soft landing chickens.
In the November 28 SPX market outlook I detailed the “structural inflation powder keg” that sits beneath the US economy. The fuse of that powder keg has been lit by the match of rapidly easing financial conditions so far in 2024, and I have maximum confidence the Fed will restart rate hikes at the December FOMC…unless there is an out-sized tightening of financial conditions in the meantime, a tightening I strongly suspect will not occur with Treasury Secretary Janet Yellen heavily incentivized to deploy her $1.1 trillion TGA/RRP liquidity bazooka to quash any and all bouts of financial market volatility, and the Fed itself making it clear through rate cut-biased forward guidance and an otherwise-illogical below-consensus tapering of UST QT that it does not want an economic downturn and/or out-sized financial market volatility ahead of Election Day.
The combination of Yellen’s liquidity bazooka and a dovish Fed (aka the FEDeral Government Put) is likely to underpin a rise in the S&P 500 to as high as 6000 by Election Day, but beneath the surface of the FEDeral Government Put the drumbeats of recession are growing louder.
As forecasted in the November 28 SPX market outlook, evidence continues to mount that the S&P 500 will enter a -50% recessionary bear market decline that runs from Election Day 2024 to Election Day 2025, taking the Index from a peak of 6000 down to 3000, or 12.5x cycle peak EPS of call it $240…right in line with the historical average recessionary bear market trough P/E.
Recession Drumbeats
As reviewed on X last night here is the timeline of the shift in FOMC messaging:
On June 3 Nick Timiraos said on CNBC that the path to a soft landing has narrowed.
Also on June 3, a Neel Kashkari FT interview was released that suggested consumers prefer to endure the unemployment impact of recession over the taxing nature of inflation.
Then on Friday June 7 Timiraos penned a long piece about the persistent delay in “the recession’s” arrival.
And then this morning, albeit not directly from Timiraos (he contributed), WSJ’s Justin Lahart wrote about how much Americans hate inflation.
Given how dovish the Fed has been all year, at first I dismissed the June 7 Timiraos piece; but then the more I thought about it, it is almost verbatim what he wrote in March 2023 just days ahead of Chair Powell’s decisive re-hawking in front of Congress. Powell’s re-hawking was immediately derailed by the SVB crisis, but it’s important to remember the backdrop that led to the re-hawking: a very similar reacceleration of economic activity and inflation to what has taken place so far YTD in 2024.
Even after Election Day the Fed will want to manage the economy lower, not see it go off a cliff as Governor Waller recently outlined. But make no mistake - this shift in language is about as direct as you’re going to see from the FOMC: they know they need a recession to get inflation durably back to 2%.
Tactical Risk & Portfolio Management
SPX has broken out and closed at a new ATH, a set-up that is unequivocally bullish. But I believe a likely hawkish June 12 event day (CPI/FOMC/SEP/Powell) could lead SPY to head back down to its May 31 low circa $518 in a classic prior low retest that happens to align with SPY’s 50dma. From there, Yellen’s liquidity bazooka is likely deployed, leading to a gappy, lockout rally into July/August before a pre-Election pullback.
I remain overweight equities in 60/40 and Long/Short, but will bring that OW up to a max OW position on a pullback to SPY $518. If we do not get the pullback, so be it. I’ll continue to sit on an OW position until upside extremes are reached.
On the FICC front, I remain adamant that UST 20s are a short & hold proposition until at least 475, if not upwards of 500 where there will likely be durable trading opportunities in both directions.