Cheap Talk

The U.S. Federal Reserve Chair, Kevin Warsh, is stuck between a rock and a hard place. Hand-picked by Trump to lower interest rates ahead of a seemingly unwinnable Midterm election, he's also dealing with a supply-shocked CPI and an inflationary AI infrastructure boom. The resultant bulge in real yields is threatening the financial stability of currency and risk asset markets.

So what does he do? Talk softly and carry no stick.

That's even if he talks at all. In his quest to distance himself from his previously loquacious predecessors, he's proposed a less-is-more approach to communications. Shorter post-meeting press releases. Less guidance. Reign in the 'dot plot' as an operational tool. Outsource your message to the market. Take off the training wheels that financial markets have been relying on since the Greenspan era.

By leaving rates unchanged in the face of a teetering bond market and energy price shock, he's signaling his intentions quite clearly. He doesn't want higher market rates, but is unwilling to do the necessary tightening to achieve that aim. And as for his proposal that the 'long end' will do the work for him, he's playing a very dangerous game.

America's last experience with laissez-faire monetary policy was during the tenure of Arthur Burns, Fed Chair, from 1970-78. He presided over an economy that experienced an oil price shock, followed by a slow economic recovery and a lackluster stock market. When inflation finally reached escape velocity in 1979, a market crash ensued as Paul Volcker administered the tough love of a 20% Fed Funds rate. In 1982, the ' long end' reaped its revenge, dropping from near 16% to 10% for a 50%+ return while stocks crashed!

U.S. Treasury 10Yr Yield - 1980-83

But I don't think we are at the breaking point just yet. Any analogy to the current situation breaks down when one considers the starting point of 10 years at 4.8% and the stock market's earnings-fueled run-up. As well, credit markets, although strained, aren't signalling any imminent threat to financial stability. Markets are richly valued, but investor exuberance is segregated to the AI space, and many stocks remain fairly valued. Although the path of least resistance is up for risk assets, the market remains vulnerable to rising real rates, as competitive yields on risk-free assets like the 30-year bond are also rising.

The experience of the past few weeks is a precursor to what will ultimately be a phase of cycle-ending rate hikes. For that to occur, we need the bottom half of the K-shaped economy to participate fully. Real wages are starting to catch up to the headlines of the affordability crisis - WestJet workers, for example.

Housing and auto demand must improve as well. It's still a bull market until it ain't.

Inflation data are being scrutinized with hyper-focus. Employment data is as well. Crowding out from rising Treasury issuance during a period of surging private credit issuance to fund the AI build-out is a real threat.  The Jackson Hole Conference is a likely pivot point for this risk. Between here and the September Fed meeting, the threat level in fixed income is DEFCON 1.

So, despite being alerted to these various threats, investors are going about their business, assuaging their FOMO. The latest promise of an Iran peace deal is deflating oil as we speak, adding to the bullishness. And Catapillar's earnings were spectacular - further evidence of the AI boom's effect on the entire economy. I postulated last week that we are getting a post-Fed recovery rally in the most oversold hyperscalers and Semis. It's not a rally I would chase, given the risks to fixed income over the next few months. And that's even before we start factoring in Mr. Trump and his band of meddling minions, as they prepare to distort the upcoming election process.

That nefarious cabal is still willing to talk, and they usually have the opposite effect on risk-taking as the now-silent Fed Chair did. As we have seen in the past, it won't come cheap for investors. Meanwhile, talk amongst yourselves.

Risk Model: 4/5 - Risk On

All clear for another week of chasing the market. Only the AAII Sentiment component is in the off position. I guess that crowd just won't get in the game, given that they still think compute is a verb, not a noun, and that Chat is something to pass the time at Timmy's.

Copper bullishness has been recently boosted by recent storms in Peru and Chile that damaged mining transport infrastructure. Possible tariff action from Trump, akin to that imposed on aluminum, is causing hoarding in the U.S. The AI infrastructure buildout is metal-intensive. All this before a sustained housing recovery!

I'm impressed by the persistence of the copper/gold ratio chart. But not surprised either! There is still a lot left in this trade.

Copper/Gold Ratio