The Fed is looking at a hefty price level

We are still in thrall to tariffs, the faux-macro “data” driving markets. The WSJ editorial board advised other countries to take their tariffs to zero so that Trump’s “reciprocal” tariffs will have to be zero, too. Cute, but no cigar.

Fromer NY Fed Pres Dudley said stagflation is the best-case scenario. More likely it full-bore recession with higher inflation to boot. Others point out the Fed is up the creek without a paddle. It has no tools to deal with an inflationary recession. It would be nice if the stock market crashes led to something the Fed can fix, like something in banking such as liquidity drying up. But credit spreads, while higher, are nowhere near crisis level.

Reuters reports “The average investment-grade spreads were at 120 basis points to end Monday trading, or 24 bps wider since last Wednesday, the widest they have been since November 2023. The average high-yield spreads at 461 bps have widened 119 bps since Wednesday and are now also at the widest level since June 2023, according to ICE BAML data. Guy LeBas, chief fixed income strategist at Janney Capital Management, said he expected to see some dip buying to emerge at some point if equity markets show signs of recovering from the recent selloff. ‘These are just sloppy, sloppy markets that don't follow any measure of fundamentals or technical,’ he said.”

Bond expert Romanchuk points out that it’s not a financial crisis until credit gets hit. “… as firms can issue new debt to roll over existing debt, the game of capitalism goes merrily along. However, if debt cannot be rolled over, activity will rapidly seize up. … If credit market conditions remain orderly, we will get a very rapid divergence between equity commentators — and the White House — and the Fed.

“The Fed is looking at a hefty price level shock coming, and so is not going to be too happy cutting rates in an environment where hard data is still based on “Pre-Liberation Day” dynamics. This would be a tricky political situation, but it is not clear that credit will be able to avoid contagion from the ongoing equity market collapse.”

While the markets expect the Fed to cut, and cut some more, not everyone is convinced. Mr. Powell said on Friday the path forward is entirely unclear. His remarks that "It is too soon to say what will be the appropriate path for monetary policy” can be seen as hawkish and possibly a challenge to Trump. After being skewered for too little, too late when supply side inflation surged during the pandemic, Powell may be serious about keeping inflation in check this time.

This puts the upcoming US CPI on Thursday very much in the spotlight.

That brings us back to the forecast from last month from ECR Research that the Fed will hike, not cut. This has some logic, but fails to deal with the near-certainty that if the Fed hikes, Trump will fire Powell and either disband the Fed or fill it with his unqualified lackeys.

One thing we must expect as consistent with Trump’s behavior—a distraction from the stock market. He sent Defense Sec Hegseth to Panama, so perhaps an invasion there. Whatever he comes up with, it will surely be in keeping with the destruction of the US’ reputation already in progress.

Meanwhile, the fear of a “Mar-a-Lago Accord” is not abating. Reuters reports “Japan's former top currency diplomat Naoyuki Shinohara said on Tuesday that any U.S. attempt to pull off a 1985 Plaza Accord-style coordinated depreciation of the dollar won't work as it would require the consent of China and Europe.

“This all raises the question of whether China's huge holdings of U.S. debt could become a weapon in the escalating game of chicken between Beijing and Washington.”

Tidbit: Let us not forget that when tariffs or sanctions hit an economy, the very first response is … smuggling. Detroit is sick with worry about auto parts from Canada and Mexico. The solution is easy—Mexico ships to Canada and smugglers bring the parts from Canada across the many, many places that can be done. Smugglers are already bringing in migrants and drugs. Auto parts, no problem. Big parts, like the steel pipes for the oil and gas industry, not so easy.

Tidbit: It looks like the giant military parade Trump didn’t get in 2018 will be happening Saturday, June 14—the 250th anniversary of the US Army and Trump’s 79th birthday. The grandiosity is in keeping with his ego and the habits of other dictators. Why the Army would help celebrate this draft-dodger is beyond imagination. We are thinking of going back to Drumpf, the original immigrant family name.

Tidbit: Talk of bringing back manufacturing to the US from places like Thailand is unbearably stupid. The average monthly wage in Thailand is $456/month (Trading Economics). In the US, it’s $5552 (Social Security Admin). What unemployed worker would go for the Thai wage when unemployment benefits or welfare yield more?

Food for Thought: What comes next? It all depends on whether this is going to end up as an unforced error/self-destruction or the feedback loop is crooked enough to sling outcomes in a different direction than what we foresee now. In other words, it will take folks outside the White House, from inside the US or outside, to shift the narrative. This is different from what Trump thinks he wants, subservient vassals bowing to the king.

Congress takes away Trump’s “emergency” power he is using for tariffs.

The Supreme Court rules on various issues against Trump.

Several countries band together to flatter and bribe. 

Canada halts all critical exports and forces a showdown.

Businesses and Wall Street gang up on Trump and also tell Congressional Republicans they will withhold primary money to ensure they lose the next election.

Protests in the US grow and grow and grow., cutting T’s approval rating to under 20%.

So far we do have big business and Wall Street, including some strong Trump supporters, increasing the output of statements critical of the tariff “policy.” We also have hundres of thousands of voter protests in every state, even red ones. If this keeps up, a crack in Trump’s tariff resolve might open.

Forecast

We were surprised that the FX market chose to buy dollars even after the 90-day hiatus was denied., Again, reasons are lacking, although yields did recover from under 4% to 4.195% by 4 pm. We might consider the more only corrective of a wildly oversold conditions, but no, the currencies went far past what a normal correction would deliver. Except “normal” is not a word relevant to today’s conditions.

At least we now know that a respite in tariff talk or a hint of an actual deal means the stock market, yields and the dollar go back up. This is silly, of course, because we have no hard evidence that the tribulation will end any time soon. Trump likes center stage too much. In a market world where neither fundamentals nor technicals have the muscle to project prices, the best course is to trade on a 10-minute timeframe or get out of Dodge. We think the dollar “should” fall again. But uncertainty is too high.

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