Force-Fed

The third rail of monetary policy, after you have taken care of inflation and unemployment, is financial stability - or lack thereof. It would appear that our feckless Fed has conveniently forgotten this.

The playbook for this year's U.S. economy was supposed to be a slowdown due to high inflation and a tightening in monetary conditions. The Independence Day bearishness centred on the price effects of Trump's tariff shocks on the economy. Then came the TACO trade. Trump's willingness to pause tariffs dispelled the notion of a full-on rout in the markets. Slowly, investors regained their appetite for risk. More importantly, the Fed, despite the inflation risks from tariffs, shifted its focus to unemployment as the primary driver of its policy choices.

However, in doing so, they are sowing the seeds of a credit-fueled boom that risks a dangerous instability down the road. I have consistently argued that the overreaching Covid-19 policy response created a situation where there was too much money chasing too few opportunities. The inflated stock market, unaffordable housing and soaring cost structure of everyday living are the legacy of those decisions. Alternative asset markets, from Bitcoin to gold, are still surging from the momentum of that stimulus. Perversely, it has also dampened demand for economically sensitive commodities, like oil, as consumers pause to adjust to the price shocks.

Perhaps as a consequence of the blatantly partisan moral suasion from Trump, or simply adhering to the unemployment/inflation playbook, Chair Powell has lowered interest rates this past month and is likely to continue the reflation strategy into the fourth quarter. However, with the economy quickly readjusting to the new tariff realities, and given the capital spending boom due to reshoring, and with AI buildouts supporting the economy, is fresh stimulus essential now? He now risks force-feeding an already satiated economy.

Yes, there will still be tariff-induced effects to absorb over the next few quarters as Trump bludgeons his way to his America First vision. With the Supreme Court threat to blanket tariffs, he has shifted tactics to sectoral ones. This week, his pet projects included movies, lumber and even vanities. At first, I thought, Why is he attacking the one thing he's best known for - vanity? But I digress.

However, taken as a whole, the tariff blitzkrieg has been somewhat overblown and is more akin to an offset to the tax and regulatory relief offered under the MAGA 'new deal'. Even bond vigilantes are cheering the positive budgetary effects of tariffs, resulting in a salubrious quiescence in fixed-income land... oh, for you bondies out there, that means you're happy.

Easy monetary conditions are the backbone of bull markets, and this one is no different. Stocks are always and everywhere a monetary phenomenon. As the chart below shows, the Financial Conditions Index is at a three-year low - meaning it's easy as hell! With ample cash in the system and a compelling narrative from the AI mania to motivate investors, the stock market has successfully achieved its primary goal: to make the most people look stupid. Since the April lows, it has done an excellent job of that.

Nervous Nellies (Deck, I mean you) are still sitting on their cash, waiting for the inevitable crash that follows a bubble-up in stock prices. The playbook is largely patterned after the infamous 2001 tech wreck era. However, the Pets-Dot-Com comparison falls short when measured against this build-out, which is fueled by wide-moat oligopolies such as Meta and Google that have strong business cases for the massive capital expenditures needed to provide the AI productivity boost that companies will require. Saying it's a bubble won't make it go away. ChatGPT is the Microsoft Excel spreadsheet of its era, and we all know how that went.

So thanks to our force-feeding Federal Reserve, the party will continue until further notice. For the left-behind bears,

Risk Model: 2/5 - Risk Off

The rally that is yet to be believed continued right through to the end of the quarter. There was no 'sell-on-news' market reaction to the widely telegraphed Fed rate decision. The Model doesn't like investing when the RSI is above 70 and the market is more than 10% above its 200 DMA. That doesn't make it wrong here after the melt-up we have seen. But man, it's getting lonely here in correction camp land. The duration of the U.S. Government shutdown and Mid-term elections are now the most likely catalysts for any pause to the rally. It certainly won't be the Fed!

The AI mania is very frothy, but that hasn't spread to the broader market. The record issuance of private credit has become a driver for markets, as seen in today's EA Sports buyout announcement. This expansion of credit has just begun to affect the financial stability measures, but once started, it inevitably ends in tears. Sideline cash is pouring into credit funds, which in turn are investing in stocks.

Bull markets always go further than you think, and easy credit conditions are a primary reason.

Monthly Private Credit Growth