Reinforcing a theme we have been on, the Fed raised the Funds Rate (FFR) yesterday and it is clear that Republican fiscal policy will have to replace the previous ‘lay down and play dead’ monetary policy of the Federal Reserve. And with the Trump administration all over the map and not yet getting much done, the fiscal side appears stuck in the mud. Not a good situation for the economy or the markets.
Yesterday morning, precious metals traders got giddy as CPI and Retail data gave the Fed a dovish out, should they have chosen to use it. I think that under the previous administration, where all there was was monetary stimulation for the economy and markets, they would have probably taken a pass and not increased the Funds Rate. But again, our theme is that the Fed is at least partially in abdication mode, with the administration tasked with doing the heavy lifting for now.
Taken in a microcosm, this is bearish for the richly valued and overbought stock market. But the FFR can climb for a long time against a bullish stock market. I don’t think it will rise to the degree of the last 2 cycles, but the key will be when the Fed over shoots the 2yr yield. The chart has not updated yesterday’s FFR move, so I have shaded where the green line should be.
The bond market (2yr yield) spent 2+ years demanding the Fed raise rates before they finally did so. Now the Fed is playing catch up. If we were to compare apples to apples, this chart says that the stock market will make its ultimate top when the FFR overshoots the 2yr yield. We are getting close and so the relationship between these interest rates is now becoming a significant caution indicator on the market.
As for gold and the precious metals, here is a view about why they are under pressure. The 10yr-2yr yield curve continues to burrow downward in a signal that there is as of yet no financial/economic stress while at the same time there are no market-based inflation signals. When this bottoms, we will have changes; the question being will those changes be liquidity stress and contraction or inflationary (due I would imagine to the Trump administration’s coming fiscal policy)? That second scenario is looking ever more precarious as the hapless admin bungles its way forward.
Here is the big picture of the curve. On the current cycle, stocks have benefited hugely from the yield curve’s message of a Goldilocks environment (global deflation set against inflationary US monetary policy). The problem now for the stock market is that the Fed is no longer in inflationary mode and the media and TV star running the country cannot get out of his own way.
Just because the yield curve is still dropping does not mean stocks are not at risk. It will bottom somewhere. At that time we might expect big-picture trends (bullish for stocks, bearish for precious metals) to change.
Meanwhile, we have been expecting the US dollar index to bottom, saddle up and start riding with the other Horseman, the Gold/Silver ratio. These would be the bringers of illiquidity and could hurt most asset markets, including initially, the precious metals and certainly commodities and other US and global ‘anti-USD’ plays. Meanwhile, we have been expecting market weakness in the 2nd half of June and a stronger USD – if that plays out as expected – could put pressure on many sectors. Again, it is summer slack season and a time for caution – and cash.
The final point I want to make is for gold bugs. This is the environment that would bring on a real buying opportunity, not the one where everybody is throwing darts at inflated asset markets and making ‘coin’. Pain first, and then down the road – after things come apart – the reward, if economic contraction and market weakness start to manifest in gold (in its risk ‘off’ suit) rising vs. not only commodities, but stocks as well.
This is just my initial take on where things stand. We will of course update the whole ball of wax in Sunday’s report. For now, it’s a risky market all around but stock trends are still bullish and precious metals are and have been trapped below key resistance.