Bears beware: the Fed has listened to the primordial scream of world markets

The Fed is trying to salvage its credibility, but things still could roll over

The events in the capital and financial markets are coming in fast and furiously over the past few days. I don’t have many answers yet, but tons of observations and ideas.

I just wanted to pass along an article I just picked up off The London Telegraph. The article titled, Bears beware: the Fed has listened to the primordial scream of world markets, provides some good analysis on why we may see the markets turn in the short-term and what this all means for the US dollar going forward.

The US Federal Reserve has called off the hounds. China has abandoned efforts to purge financial excess, reverting to stimulus on multiple fronts.

Policy pirouettes by the world’s twin superpowers mark a critical moment in the tightening cycle, with sweeping implications for global asset markets and for the health of the international economy over the next year.

Bears beware: the Fed has listened to the primordial scream of world markets – The London Telegraph (January 6th)

It is worthwhile to entertain the thought that the Chinese and American monetary policy authorities may be working together while they attempt to fashion some sort of trade package. We also observed how the Fed chiefs all came out in a unified fashion late last week to promote their new mindset. This was a sudden turn of philosophy. Perhaps, Dow 22,000 was the Maginot line.

This was a far cry from his [Jerome Powell’s] comment before Christmas that the Fed’s pre-set plan to shrink the balance sheet by $50 billion a month was on “autopilot” — even though half the world was by then in flames. In the US itself the Goldman Sachs Financial Conditions Index had jumped 100 basis points since early October.

The new line is clearly a concerted Fed message. A day earlier Robert Kaplan from the Dallas branch said he was watching “very, very carefully” lest QT causes liquidity to evaporate and leads to a crunch.

It is the reassurance that skittish investors have been waiting for after a $20 trillion slide in global equities and signs of seizure in the credit markets. The S&P 500 index of equities roared 3.4 percent within hours. January suddenly feels different.

Bears beware: the Fed has listened to the primordial scream of world markets – The London Telegraph (January 6th)

Regardless, I still believe there is further rot in the credit markets that have yet to fully manifest. In the short-term, this does little to alleviate the global economic strains and stresses and we still may experience intermediate-term economic problems. My concern is that these monetary policy actions may not provide enough help and could be coming too late to stop what is coming.

While this could provide us with some good long trading opportunities, I am concerned that if events turn darker, the Fed could lose some of its standing.

Does the Fed know something?

I am contemplating a weaker dollar (and firmer gold prices?)

In a recent article I posted, we discussed how the dollar might begin to lose some of its recent strength. I enumerated in my December 25th blog post, Are the planets aligning against the US dollar?, that the dollar bulls may be mistaken in guessing about further dollar strength in the short- to intermediate-term.

Ironically, I based some of my reasoning on the fact I thought the Fed’s tight policy was irrational and that some investors could begin to spot structural problems.  Clearly, President Trump’s ostensibly unstable behavior was not helping the situation.

Now that the Fed has become more dovish, the dollar still could fall as global funding stresses may abate. In addition, short-term rate differentials may narrow around the globe. If the Fed keeps its balance sheet at a larger-than-anticipated size, there will be more dollars in the global economy.

The dollar may top out as dollarized funding pressures could recede under a dovish Fed policy

It is the Fed that matters most. For the last year it has been draining dollar liquidity mercilessly, both by shrinking the balance sheet and by raising rates. The “broad” dollar index has soared to an 18-year high.

The squeeze has been slow torture for a world financial system that has never been more dollarized or more sensitive to US borrowing costs, especially in those emerging markets that were flooded — nolens volens — with cheap dollar debt during the QE years.

Turkey and Argentina were the prime casualties of 2018, but South Africa, The Philippines, Indonesia, India, Mexico, and in its way China have all suffered.

Offshore dollar debts worldwide have ballooned to $12.8 trillion (BIS data). Roughly $4 trillion of contracts outside the US are priced off three-month Libor rates alone, which have doubled over the last year.

The strains reached breaking point in the fourth quarter. Dollar funding markets in Asia and Europe began to dry up. High-yield credit spreads have surged by over 260 basis points in Europe, where bank stocks have been in free-fall.

Bears beware: the Fed has listened to the primordial scream of world markets – The London Telegraph (January 6th)

If the dollar fades, which it should under a dovish policy and lessening funding constraints, I believe gold could follow through and take out $1,300 on a trading basis. I am not claiming to be outright bearish on the US dollar, but I am no longer bullish.  Could commodities tick up here?

Keep in mind we could also see further dollar weakness if the markets begin to worry about whether the Fed policy changes have something to do with something the Fed sees, but has not made public.

Like I said; so many thoughts, but few answers….