Carlsquare weekly market letter: Does the Fed know something we don’t?

• As expected, Jerome Powell flipped from hawk to dove. We expected that. But we were surprised by the magnitude of the change. Now the market is pricing in a double hike and a long period of cuts. Why so sudden?
• The answer may lie in the presidential election. People overestimate the impact that the candidates will have on the market. This year, both candidates are talking about spending, so the difference between them will be very small from a stock market perspective
• Could it be that Powell sees something we don’t (like a looming liquidity crisis in the making), or is he simply positioning himself to be elected for a new term, as wicked tongues whisper?

The stock market received a further boost from Jerome Powell’s speech at Jackson Hole, which gave the market the impression that the Fed had switched from raising interest rates to lowering them.

Inflation has fallen, as has employment, giving the Fed room to manoeuvre.

The US deficit is still growing on an unhealthy path that will eventually end in a crash. But it is impossible to guess when this will happen.

The first signs will be seen in the junk bond market, but that market is now on a rally, showing an encouraging appetite for risk.

From a stock market perspective, we don’t see any difference between the US presidential candidates. Both are focused on spending and stimulus, which seems irresponsible from a fiscal perspective, but good from a short-term equity perspective.

An interesting study can be found here at visual capitalist:

https://www.visualcapitalist.com/sp/democrats-vs-republicans-does-it-matter-to-the-market/

With the US government selling more bonds and the Fed not picking up the tab, liquidity is tightening. That could be the mantra for a few months.

M2 is one of the measures of liquidity in the economy (cash and bank deposits, etc.). M2 growth is slowing, which is alarming.

The picture is even clearer when we look at the velocity of money in the US economy.

The velocity of money is the rate at which money is exchanged in an economy and is defined as the ratio of gross domestic product (GDP) to a country’s money supply (M2). It is explained by the number of times a unit of currency moves from one entity to another in any given period. Simply put, it’s the rate at which consumers and businesses in an economy collectively spend money.

When the velocity falls, the economy goes into recession. The Fed can use the federal funds rate as a tool to increase activity. But it is even more powerful to increase money in the system in the form of credit and loans (buying assets). So, we will see what the Fed does, but we expect more tools to come.

We are positive for the long term and see setbacks as buying opportunities, although we expect the market to be volatile.

The S&P 500 is currently trading within its old positive trading range.

The fall in the US dollar is a driver for the market. If the USD is weak, the stock market rally can continue.

With Nvidia due to report this evening, there is no point in going any deeper into the market. It is better to wait for the results than to speculate. And don’t forget that it’s the market’s reaction that matters, not the actual numbers.

Happy trading!

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