Fed Put for Market vs Fed Put for Society. Which way will they go?
The question investors need to ask right now is whether or not there is a “Fed Put” to save the market if risk starts to get sold off further because of the beginning of their tightening cycle or whether there is a “Fed Put” to save society from having to experience unanchored inflation. For the last 20+ years, investors have been safely able to say the “Fed Put” is for the market because there has largely been no inflation, which has allowed a BTFD mentality that has served investors very well. However, I now believe the Fed is shifting from using its “Put” to save the market to using its “Put” to save society.
I know I am making a “this time is different” argument, which is always a tough sell, however it is based on the combination of the following four factors: 1) real data that shows both inflation and forwards inflationary expectations beginning to rise uncomfortably, 2) a noticeable change in the societal psyche recognizing that inflation is here to stay focusing citizens to act accordingly (real asset buying, hoarding of goods, demanding higher wages, etc.), 3) horrible polling data for the Biden administration that has re-nominated Powell/Brainard on the premise that they will push more aggressively to make sure high inflation in not an election issue this fall, and 4) rising social unrest globally due to both rising inflation (see Kazakhstan; potential for Arab Spring 2.0) and lockdowns, which is leading to higher prices that citizens are struggling to pay for.
The Fed has shifted aggressively in the last three months as these four factors have continued to accelerate. They have raised rate hike expectations, accelerated the tapering of their asset purchases and are now discussing reducing the size of their bloated balance sheet. While on the margin, investors are starting to notice, I keep hearing that the Fed won’t actually go through with this tightening of financial conditions agenda. I think that is wrong…by a mile.
Below is a 10 year chart of financial conditions. We remain in the lower decile for the last 10 years of observations. There is simply not enough concern from financial markets of the tightening agenda the Fed is about to undertake. Rates and FX markets have started to notice, as have more speculative areas of markets (crypto, SPACS, etc), however major asset classes are still broadly overvalued for the amount of tightening that is about to take place. As the Fed favors society over the markets, their “Put” to change back course will be struck at much more lower. Time to be hedged up and short major indices against core long ideas