The Pivot Fallacy

Haaaa ha ha ha haaaaa. Hello, dear friends. I'm back with another economic update for you.

Have you ever seen those old videos of Evel Knievel, the legendary stunt performer, taking his motorcycle and jumping over parts of the Grand Canyon? If he misjudged the speed of his motorcycle, the incline of the ramp, the distance of the jump...any slight miscalculation and the fall would certainly kill him. But he was an artist, and the variables he was working with were few. The only real secret ingredient to his success was courage.

Now imagine Federal Reserve Chairman Jay Powell in that motorcycle. Wearing the American cape on his back, there is determination on his face. He revs up the engine, sending the interest rates up many hundreds of basis points. His motorcycle hits the inclined ramp at an incredible speed, crushing residential and commercial real estate, tightening credit, setting off layoffs in the tech industry. And then at the very peak of his flight, he pivots, cutting interest rates back to zero, and landing safely on the other side. The crowd goes wild, investors throw themselves at his feet. He has achieved soft landing.

That's the fairy tale the stock market is feeding itself these days in a state of frenzied ecstasy. Sure ole Jay can do it. He can raise rates at historic rates for more than a year, and then when the economy goes into recession, he can quickly cut rates back to zero, and all will be well. No need to look down to see how deep the canyon is. He can make the jump.

This is a foolhardy assumption. The Federal Reserve board and it's chairman have made it clear multiple times that their priority right now is getting inflation back down to 2 percent, by creating tightness in the labor market. Which is Fed Speak for "we want people to get laid off and stop spending". Unemployment is a lagging indicator, usually the last shoe to drop in a slowing economy. So the Fed is ignoring all the coincident indicators that show that the economy is slowing dramatically, and riding that motorcycle looking in the rearview mirror. Even as all the forward looking indicators are flashing Red, the Fed is STILL raising rates. After the humiliation of getting "transitory inflation" call so wrong, they are determined to over correct on the other side. Jay Powell has made it clear that PAIN will be involved. Which means no PIVOT to cutting rates is coming. Not unless things break so badly that the Fed is forced to abandon it's inflation fight.

It's incredible that this is the thesis the market is resting it's hopes on. That the credit tightens so dramatically, and things break so clearly, the Fed is forced to pivot on it's policy stance. Even if the Fed does cut rates, like it has historically during economic crises, that pivot is usually accompanied by a crashing stock market. And low rates are no immediate panacea either. Just like high rates take anywhere between 12 to 18 months to show up in the economy, it's the same in converse when you're cutting rates. No matter what the Fed does, we WILL go through a severe downturn in the coming quarters. Pivot or not, an earnings recession is on it's way, combined with higher unemployment. The passive flows from retirement accounts into the stock market ETFs and mutual funds will reduce liquidity during a recession, as people get laid off or reduce contributions or reallocate assets. Credit is already tightening due to QT and higher rates. Add to that the regional bank crisis, which will tighten the availability of credit even more. After the failure of Silicon Valley Bank, which was the second largest in the American history, First Republic, another large regional presence, is now on the chopping block. As i give this market update on the 29th of April, it's likely that First Republic goes into receivership with the FDIC come Monday. More credit tightening.

The current fallacy of the Fed Pivot being a cure for a falling stock market will take retail investors by surprise, when they find that the act of cutting rates coincides with devastating financial events, and the Fed like always, will be way behind the curve, trying to dowse a fire they themselves started. To complete the motorcycle analogy, nobody knows how deep that canyon goes. Nobody. You're better off just clapping from the sidelines, as the Fed's motorcycle vanishes into the dark abyss. 

Cheerio!