In the land of make-believe, everything must be perfect – or there will be no milk and honey. It is a good day to be in cash, as interest rates and the bond market went on a rampage after Fed Chairman Powell signaled a “tolerance” for “upward pressure on prices” and “patience” for the rise in 10-year rates he “admitted” to having “noticed” recently. 

Clearly, Chairman Powell has enough discretionary income to tolerate higher prices for everything. The average person doesn’t. With those statements, the dream world for the stock market we have enjoyed since last March ended. Remember this day, and remember it well.

All bets are off now, though the markets will continue to offer us trading opportunities. Why the bond market revolt? Governments have a poor history of containing inflation once it is out of the box. What the market anticipates is a coming change in Fed policy. 

A smart Fed cannot be so accommodative and will need to reverse course, taking away the punch bowl at this party. A dumb Fed will continue current policies and start the road to oblivion, the one that eventually caused the collapse of the German Mark in the 1920s. 

Short-rates are already close to zero, so lowering rates further is hardly an option to appease investors. The Fed can “twist” the bond market, selling short-term bills and buying longer-term notes. The Fed can double down on quantitative easing as Australia did over the weekend. But then where does it all end? When does the Fed take the punch bowl away, and at what price?

Think back to 2018. The Fed attempted a return to “normalcy” by easing its balance sheet and raising rates a couple of times. The stock market went into a 20% correction that August, putting President Trump into a tizzy. The market did not bottom until Christmas eve. The equity markets are more overvalued now than they were then. If the Fed now doubles down on the easy-money policies and continues to print money, where will the market go when the music finally stops? From what level?

You see, it is damned if he does and damned if he doesn’t. For the moment, thank heavens we still have enough of a free bond market left to wake Powell up. I sincerely hope he takes the red pill. It will be a rocky road into the next Fed meeting, scheduled for mid-March.

Hat tip to the NASDAQ 100, it saw this moment coming. That is why it has underperformed so significantly these past few weeks, leading the rest of the market down. Hat tip also to oil, up nearly 4% today while everything else is red. You see, oil loves inflation. Gold, not so much. It is down with the rest of the market. Gold raises currency complications – we will need to sort that out in the coming days.

In the meantime, it is nice to be in cash today. I gave it my best shot catching the volatility of the past few weeks, but I was smart enough to throw in the towel yesterday afternoon. Small profits are better than losses. I bailed yesterday on the WWSHD signal. When what should happen doesn’t.

Stay Tuned,

A.F. Thornton