Stock Market Cliff Dive
David Haggith

News today really puts the Fed in a tough bind and strips away investor delusions about rate cuts.

Such a torrent of horrible economic news hit today, particularly for the Fed, that I cannot even begin to cover it all in a weekday editorial, so a good part of it will have to wait for my weekend Deeper Dive, and even that may not be able to cover it all; but I don’t want to miss a drop.

Speaking of drops, though, stocks, today, took a big one! April just fooled stock investors by becoming the first losing month of 2024! For the Dow, each month this year rose a little more than the month before, building momentum for the MOMO crowd, until April fell more than double what any one of the other months rose! It fell, in fact, almost exactly as much as the entire year’s gain! That makes 2024, so far, a really lousy year for stocks unless you got out in March or made some smart shifts to a very limited number of gainers. Or unless you shorted the market!

While the Dow plunged 570 points today (1.5%) because of the terrible news (that is the kind of news I’ve been saying will crack the market’s delusions regarding inflation, Fed rate cuts, and any hope of a soft landing), the Nasdaq plummeted 2% to end down 325 points. It particularly nose-dived right at the end of the day, falling more in the last ten minutes than it had since the start of the day. For the Dow, April turned in the index’s worst monthly performance since September, 2022. With that, all five major indices snapped five-month winning streaks.

The big fear factor at the end of the day appeared to be what tomorrow holds as wage data earlier in the day showed inflation, which is often seen as driven by wages, is likely to rise even faster now than it has through the first four months of this year. Wages took a sizable inflationary jump in today’s report, giving plenty of reason for stock investors to fear that the Fed is going to take a big baseball bat to their knee caps tomorrow by smashing down any remaining hopes of a rate cut this year.

Of course, markets do not tell you what they fear, and there were plenty of other data that came in today that upset markets, but analysts seemed to focus most on the wage data.

The new labor cost report is “not a number that will incline the Fed to change their ‘there is no rush to ease’ stance,” said Tom Fitzpatrick, managing director for global market insights at R.J. O’Brien and Associates.

The sudden drop gave the appearance that markets were desperately hoping something would arrive in the data today that would provide a last-minute reason for Fed cuts to come soon; and some of the bad news about the economy could have done that, but the bad news regarding inflation bit the hardest. It was as if investors were waiting for a clincher for a rate cut all the way to the last part of the day and then threw in the towel and ran while there were a few minutes to get out. I don’t know, of course, the the market’s collective reasoning (if it can be called that in these dimwitted days of mass euphoria over impossible prospects), but the day had that look of fearful investors holding out to the bitter end, then giving up because no last-minute news came in. So, maybe it was the lack of any positive news regarding inflation at the last minute to revive flagging desperate hopes that drove the market down, more than any particular bad news.

“When you look at the size and the scope and the scale of the rally off the October lows, and then you layer on top of it, the stickiness of inflation in the end … I wouldn’t be surprised to see some dampener on the market for a little period of time,” Dan Greenhaus, chief strategist at Solus Alternative Asset Management, told CNBC’s “Closing Bell.”

Of course, the rally off the October lows, was entirely based on false hope triggered by J. Powell when he said that the market’s work of tightening financial conditions meant the Fed may be able to quit tightening sooner, rather than later. With no basis, the market turned that vague but soft-sounding statement into a Fed pivot in March with another five to six cuts to follow this year. Every month since January has eaten away at that illusion until not much remains. I expect that the full rally that was based on those hopes gets eaten up by the continued breakdown of that delusional thinking. 

Reality has a way of crashing through denial eventually, and that is what is happening. The dismal truth about inflation rising every month this year (and in prior months for those who knew where to look to see beneath the more blatant headline numbers in order to tell what is coming) is making it clearer that the Fed was never in a position of being able to start cutting rates anytime soon because inflation is just that hard to fight. The battle is long and always puts in an extra-tough second half where it becomes anyone’s game. The second half started as the Fed’s game to lose, and the Fed is now clearly doing just that. That means it will have to speak a little rougher if it wants markets to go back to doing the hard of battling down inflation by raising interest rates, and I think markets are fearing that tougher talk tomorrow.

The bigger they are, the harder they fall, of course, So, Nvidia and other AI stocks that led the delusional parade uphill have led the more ordinary Jack-and-Jill stocks’ tumble back down. Most financial writers believed tech stocks had a lot of room to rise so there was little chance of a big fall; but many have already achieved their own bear markets! They thought that because they forgot that room to run in the more distant future doesn’t mean they did’t overshoot in the present and couldn’t do exactly as tech stocks did during the dot-com bust, even though those companies, too, ultimately had glorious futures ahead of them (or, at least, the ones that survived did).

Die hard divers

Still, delusions die hard. Zero Hedge almost veered back to hyping the rate-cut narrative as it did for well over a year with its “Fed pivot” promises, or so it appeared in one title today. This time, it is not them claiming a premature pivot, however, but is just an article they carried, claiming one should not buy the rate-hike hype but should be ready for the Fed’s first cut.

The Federal Reserve’s next move this year is likely to be a rate cut - despite the re-emergence of inflation - leaving markets at risk of a dovish repricing.

So says Simon White, a Bloomberg macro strategist. It would hardly be dovish repricing since they haven’t fully gotten the rate-cut hysteria whacked out of them yet.

Having said that, his belief about the Fed’s action is no longer without merit, as I pointed out the possibility in an article of my own yesterday. It would be a catastrophically dumb move, but it is not out of line to think the Fed would make a catastrophically dumb move in order to save the US government and the Biden administration from getting voted out:

When it comes to the Fed, it’s easy to get hung up on what they should do, and neglect what they actually will do. From an inflation perspective, it’s becoming increasingly clear the central bank needs to raise rates further to quell resurgent price growth. But that’s unlikely. Instead, the risks to government funding costs and mounting pressure on liquidity are likely to tilt the Fed in favor of cutting rates, even as inflation is making an unwelcome return. 

I don’t think that is the move they will make, but I do think they will slow down their QT rate of taking down foundational money supply. I think we’ll hear something about that tomorrow, and that may give the stock market another momentary reprieve as something dumb for it to fasten upon, which would be idiotic on the Fed’s part because a strong stock market makes their inflation fight harder. However, the Fed appears to be working in consort with the Treasury to ease the government’s now extreme funding burdens, as I wrote about yesterday. (See “The Federal Reserve Is About to Go Full Banana Republic.”) 

Since the Fed has made plenty of idiotic moves all along, such as its naive choice to keep pumping money into the economy because it believed inflation was transitory, there is no reason to think it wouldn’t do something that will make its trouble worse now, just as Powell did with his lame announcement in November that the battle might be over soon if financial markets kept up the hard work, virtually assuring they would NOT keep up the hard work. If he wanted markets to keep up the hard work, he should have kept his mouth shut. It was obvious these hormone-driven markets (both stocks and bonds) would rise again on the faintest hope from the Fed that it would soon be done fighting inflation.

White points out that the Treasury’s quarterly refinancing announcement, which came out on Monday, shows us why the Fed will move to cut rates. I say, the Fed will cut QT, and that ultimately has the same effect, but rate cuts will remain off the table, likely for the rest of the year.

This week again draws focus to the greater entanglement of monetary and fiscal policy. The Fed meets on Wednesday, but the Treasury’s QRA (quarterly refinancing announcement) is just as consequential for the path of monetary policy.

It sure seems it will be for QT. It, of course, shouldn’t be for either QT or interest rates. By law, the Fed should not be setting monetary policy in order to fund the government. That is not one of its mandates, and it breaks the wall that is supposed to exist between the central banks and government influence since the Fed would not even be considering such a move if the Biden government were not running massive deficits like the Trump government did. The Fed is not supposed to be using monetary policy to make government debt easier to carry, but that doesn’t mean it won’t.

The amounts are eye-watering - $243 billion in 2Q and $847 billion in 3Q - and unthinkable outside a recession only a few years ago. The market is gradually waking up to the Treasury put and the realization the fiscal deficit is unlikely to go back to a non-recessionary norm any time soon. Term premium is rising as lenders demand greater compensation for holding longer-term debt.

Term premium, means bond investors are wanting more because they see inflation eating away at their interest over the term of the bond. However, that should be the government’s problem and not the Fed’s to fund with looser and looser monetary policy, instead of a tough fight against inflation. When inflation rises because the Fed takes this step (IF it takes this step), remember inflation is, at that point, exactly a tax upon you and one that hits the poorest the hardest as they spend every dollar they make. It is EXACTLY a tax if it is rising because the Fed is not fighting inflation as hard in order to help fund the government’s projects.

The government has a problem, and White says the Fed will rush to the rescue. It wouldn’t surprise me at all, though rate cuts are not the approach I think they’ll take, but it will be a terrible decision that steps us fully into banana-republic world if the Fed does that, and it will be illegal, though no one in government is likely to care because they don’t want the burden of solving a debt crisis they have been building for a long time.

The Fed is thus likely to cut rates in a quid pro quo with the Treasury. This would not only help the government fulfill its borrowing requirements at a non-usurious cost, it also helps the Fed with its responsibility for financial stability by taking the pressure off risk assets and reducing the likelihood of a funding squeeze.

Even though such a move would be unwise, it doesn’t mean it won’t happen. Cutting rates before inflation has been snuffed out threatens to intensify structural risks for price growth.

No kidding. It would be an inflation disaster. If the Fed cut rates for financial stability as White says, that would be one thing, but they wouldn’t be doing it for financial stability because financial stability requires a stable currency, and cutting rates now because the government needs the help now would be terrible for currency stability. It would throw gasoline on those rising flames of inflation. The Fed knows it will be blamed if inflation rises due to lowering rates. QT? Maybe not so much as people are not as sure what to make of that.

But in the heat of liquidity drying up, funding risks rising, markets on increasingly shaky ground, and the government locked in an issuance doom-loop as its interest costs soar, the Fed is likely to cut rates as an easy first move to ease the pressure — an outcome made even more likely with an election looming….

This would be yet another chip in the de facto erosion of Fed independence. 

In my opinion, it would be more than a chip. It would be a two-footed plunge; but he’s definitely right about the pressures that have built up and maybe about doing it for electioneering reasons, too.

In my weekend Deeper Dive for paying subscribers I’ll lay out how the Fed’s Runway for its soft landing is breaking up under tectonic stresses (based on today’s stories and others) as the Fed comes in on approach, and the Fed’s plane was made by bean-counter Boeing, so it’s front landing gear has fallen off. Stay tuned for “The Deeper Dive: Fed's Crash Landing Nears!” I’m saving the worst of today’s news for that deeper exploration. (That is, of course, unless even worse economic news appears in what is left of the week … as looks reasonably likely.)

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