Powell is scared!

“I'm not even a little bit happy” with Powell, the Fed Chairman. This is what President Trump said publically. Apparently Trump has increased his rhetorical criticism on Powell recently. By the way, no president is happy with any Fed Chair when they are increasing the rate, period! But Trump is the only one in the recent history who openly criticizes the Fed Chair. Then just the day after the criticism, Powell sent a very dovish signal to the market that the Fed will likely pause the rate hike soon as we are just below the "neutral rate" that is the target for the Fed. Temporally it seems quite clear that Powell was scared by Trump's escalating rhetoric attack. But the real reason I think is that Powell is scared of something else and he must to do something to calm the market. It is the bond market warning signal that really has scared Powell, not Trump! Let me explain.


I have talked about the coming bond crisis not long ago (see here). The biggest threat is the unavoidable junk bond fallout in the next few years. Of course, the crisis will not surface if the interest rate is kept low but it will quickly become more and more a serious problem due to its size and the number of companies involved. We are talking about a few trillions of dollars worth of junk bonds that are due in the next 3-5 years. When the interest rate goes up in a fast pace, the junk bond market feels the pressure and has negatively reacted not seen in the past few years. See below the junk bond chart for HYG. It has been basically walking on the sideways for the last two years in the tight range $85-90. Then it started to break down recently. Don't take it lightly, friends. Junk bonds are usually the leading indicator for the market and they are most vulnerable to the rate increase. Think about it. If trillions of dollar bonds suddenly cannot meet the legal requirement to pay the interest and go under belly, what kind of impact it will have for the economy? Powell knows very well the dire consequences and he has got the message from the warning. That's why he softened his tone to signal that the rate hike will not continue in a fast pace as previously expected and will likely pause for a while next year. The market was apparently happy with what he signaled with a big daily jump rarely seen in the past few weeks. I think the market has found a good footing with Fed's support and is ready for its next leg up that may last for months into 2019.


Of course, don't expect a straight line up but more volatility along the way. The most imminent significant headline risk is the Trump/Xi summit tomorrow.  The general expectation is very low and don't see a positive outcome to come out of the meeting. Somehow I'm more optimistic and think a better than expected outcome with a goodwill deal may very well materialize. Here is what I think what will happen between the two Presidents:




Trump: Hi, Lao Xi. Long time no see! How is thing going?
Xi: Cannot be worse, thanks to you, Lao Cuan! Why do you want to corner me without giving me any leeway with this stupid trade thing?
Trump: Come on buddy! You have all the power in your country that everyone has to follow your order. But for me? I have to fight for everything!! So you really should feel very good with that even though I do understand this trade stuff may have caused some frustration for you.
Xi: I tell you it is really face losing for me, guy!
Trump: OK. Since it is not a pleasant situation for both of us, why not we use this opportunity to work out something to please our people at home? After all, we are good friends, right?
Xi: Oh, yes! Let's do it tonight after the dinner!!

😏😇😎

Then we will likely see a pleasant surprise on Sunday that both US and China have agreed on a concrete framework to work out the differences on the trade issue. If this is indeed the case, look for another strong rally towards the 50 DMV which is little bit below 2800 at the moment for S&P. If the year end rally is indeed real, then we probably will a lot more than that in the final few weeks. One side note. I thought there would be some nervous selloff today in front of the upcoming uncertainty about the meeting outcome. So I took off quite a few nice gains from the positions I placed in the past two weeks or so to be ready for a negative shock. But the market is anything but predictable on its daily moves. I'm very impressed by the final hour strong up move today. I guess more people feel the same way as I have been now for a good outcome. But if not, then the market may likely tank severely as well. So in any way, I'm not regretted to take off some chips today! Purely from the risk benefit perspective, it is not a good idea to chase highs from here. Many people can get killed if not well prepared for the potential disappointment. I'm positive but not 100% assured.