Deflationary bust for stocks, or a Fed pause beforehand?
We evaluate the risks in markets moving into Q4 as the Fed continues aggressively hiking.
Dear readers,
Stocks are in a state of denial. Their refusal to dump in extraordinary fashion suggests this. They deny that the Fed has any meaningful runway to continue hiking and anticipate a shift to supportive monetary policy. Hence, risk assets haven’t experienced the same level of volatility as bonds or currency markets, which have lived in absolute fear since the end of last year.
Are risk assets sniffing out a Fed pause elicited by global markets turmoil, or are we in for a crescendo risk-asset selloff as the Fed overtightens? We’ll take the former, Alex.
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Today’s topics
Stocks are calling the Fed’s bluff but aren’t always the most reliable leading indicator.
Capital being drained from the Fed’s RRP facility signals a potential shift for risk.
Financial turmoil in Europe could spur a Fed pause before risk assets explode.
Stocks are calling the Fed’s (perceived) bluff
At the time of writing, there stand two 30,000-foot possibilities for markets:
Crisis Realized
Growth Slowdown → Overtightening, Recession, Risk Selloff → Rate Cuts
Crisis Averted
Growth Slowdown → Fed Raises Rates To 4.5%-5% → Rate Pause
Global bonds have sold off and foreign exchange (FX) markets have experienced heightened volatility due to the expectation of continued rate hikes.
Stocks, and other risk assets, are less convinced of this eventuality. Equity volatility (VIX) has been less, well, volatile. Bitcoin has also dropped its trademark price swings in favor of a sideways crabwalk. They seem to be sniffing out a potential shift in policy that would accommodate risk assets.
VIX is not matching the same level of volatility—our best proxy for fear—in bond and currency markets: