Posted by on July 15, 2017 12:52 pm
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Categories: British Pound Business CPI Economy Federal Reserve System Finance Financial economics Inflation Inflation targeting Mathematical finance Michigan Monetary Policy money Precious Metals stock market Technical Analysis the University of Michigan University Of Michigan US Federal Reserve VIX

Authored by Kevin Muir via The Macro Tourist

Stocks Dare The Fed

It was only a month ago Fed President Dudley was lecturing us about the dangers of overly easy financial conditions and how inflation’s sanguine performance was “transitory.” And it wasn’t like he was alone. The Fed’s generally accepted second in command, Stanley Fischer, echoed similar comments.

Well, on Friday morning about the most awkward economic news possible was released. CPI undershot, coming in at 1.6% instead of the expected 1.7%. Retail sales were abysmal, registering -0.2% instead of the forecasted 0.1% gain. And the University of Michigan sentiment numbers reflected a public who is becoming increasingly skeptical of the Fed’s rosy outlook. The actual index was 93.1 instead of the surveyed 95.0, but more importantly, expectations plumetted to 80.2 instead of 84.4.

This puts the Fed in a terrible place. It is obvious they have whiffed badly when it comes to meeting their inflation target. This morning Fed President Evans said “low U.S. inflation is a serious policy outcome miss.” Yeah, you don’t say? Well, what did you expect? Raising rates into an obvious economic slowdown will have that effect on inflation.

But you have to think Dudley and Fischer were aware of this possiblity when they made their comments about financial conditions comments. So now the real question is how much they are prepared to follow up their words with deeds.

Make no mistake, the market will test them. Given that the market is now convinced the Fed is on the sidelines, the last remaining potential bearish catalyst has suddenly evaporated. With the weight of a heavily handed Fed lifted, stocks, and financial conditions in general, will explode higher.

And when they do, it will make Dudley, Fischer, and I also assume Yellen, extremely nervous. Stocks will almost dare the Fed to raise rates.

I can’t help but be reminded of the batter in the song Paradise by the Dashboard Light. You know the line – “Holy cow, stolen base! He’s taking a pretty big lead out there. Almost daring him to try and pick him off.”

That’s the stock market. Already on third, pushing their luck, challenging the Fed to call their bluff.

I am not smart enough to know how the Fed will react. Nor do I know how far stocks might run. This is a dangerous moment.

Yet I have a few random thoughts that I am going to stew over this weekend.

Don’t look now, but the British Pound just made a quiet Friday afternoon breakout.

And although I am loathed to sell the US dollar down here, I am becoming even more enamoured with precious metals. Gold and silver have been crushed by rising US short rates. If the Fed blinks, they might be due for a nice pop.

Finally, although most stock market bulls believe a rising market goes hand in hand with a collapsing VIX, I think there is a decent chance we could have both stocks and VIX rise from here. I might play it by buying stocks and VXX, but a better way to express that view might just be outright long positions in SPX calls.

The market is at an inflection point, and it should be interesting to see how both the Fed, and market participants, deal with this new dilemma. Hold on to your hats, “here he comes, squeeze play, it’s gonna be close… Holy cow I think he’s gonna make it!”

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