Buckley's Remedy

Taking the medicine that cures your ills is always hard. In the pantheon of home remedies, Buckley's takes first prize for turning this fact into a marketing success. They profited from people's aversion to taking medicine that was designed to cure their sickness. The question is, can the stewards of the global economy do the same?

For those who remain bullish in this full-on bear market, what you should now be cheering is bad news. For the market to really reverse course there is only one quick way out, a hard landing. But once the economy has decelerated sufficiently to allow expectations to bottom, what is the path forward? Is it a touch and go or do we head to the taxiway and turn off the engines?

The book on Chair Powell and Secretary Yellen is for a left-leaning bias towards employment concerns that dominate their policy thinking. That will play well in an election year, but is it the best policy to adopt, given the now intractable inflation psychology that dominates financial markets? I think not.

Within the halls of the Federal Reserve, there is a level of angst not experienced since the late 1970s.

Their much-ballyhooed models, having now spectacularly failed in predicting the current inflationary surge, are being furiously reworked by the 250 PhD worker bees at the Fed. Unfortunately for them, the endowment bias created by their position as purveyors of the World's reserve currency left them vulnerable to this failure.

As I have said many times, the basic inconsistency of their domestically focussed mandate juxtaposed with the global scope leads to this estimate error. Just seeing the Bank of Japan, who is gleefully committing currency hari-kari, tells you that all roads to monetary discipline lead to Washington. All eyes are now turning to Powell & Co. for leadership. Unfortunately, he reports to U.S. Congress, not the IMF.

That Achilles heel of the global financial system, argues for a softer approach to monetary conditions than is necessary to slay the dragon of inflation.

So now that we have peak pessimism on the front page, a bounce is forming in risk markets. The safety valve of lower yields was tripped last week, mostly due to the self-fulfilling negative headlines generated by the perma-doom crowd. Google search data saw a peak in the keyword 'recession' last week and, voilá, bottom in the market this week. But how can you trust that all elements are in place for a durable new bull market? The cause of the bear has its germination in the laissez-faire monetary policies that have systematically prioritized employment over inflation. Now that inflation has the upper hand on all policymakers, the harsh medicine we need is obvious but highly unpalatable to the economy's medical staff - The Fed.

Price-cap headlines and recession fears have allowed oil prices to moderate this week. unfortunately, we are just one refinery fire away from $6/gallon gas, given the low level of surplus refinery capacity. By now the oil companies have built inventories sufficiently and the summer swoon in energy equities that seasonally follows the Memorial Day hype is in full swing. This will be the key determinant to use for a short-term forecast of market behaviour. Gasoline and the SPY are now highly inversely correlated. Good luck bounce traders, I don't think we are out of the woods on energy prices yet.

But since Powell isn't likely to offer us the bad taste of monetary Buckley's, $6/gallon could just be the medicine we need. I'm willing to swallow that.

Risk Model: 0/5 - Risk Off

With a scant 7 days of trading left in the quarter and not much liquidity to work with, I suspect a choppy upward bias in the markets. Bottom fishing will dominate now that the economic expectation reset has been hashed out in the press. My thanks to long-time blog fan, Larry Summers for the negative headlines this week. Somebody had to say "the economic emperor has no clothes".

The Copper/Gold breakdown is now progressing nicely as we purge all thoughts of a stronger second half for global growth. I'm covering my FXC short today but will look to re-enter that trade soon. For long-short players, try CNQ/FM after the bounce peters out.

Copper/Gold

Ratio: CNQ/FM