Higher For Longer – Into The Teeth of Trouble – June 23, 2023

Higher For Longer – Into The Teeth of Trouble – June 23, 2023
Morgan Lewis Posted on June 24, 2023

Higher For Longer—Into The Teeth of Trouble

This week, HAI is necessarily brief. The author is currently flying high over the beloved United States. As a result, HAI will be condensed, not just this week but over the next several weeks due to family summer travel plans. Over the coming weeks, HAI will strive to deliver the most crucial market moving developments, but also recommends that readers turn to Doug Noland’s Credit Bubble Bulletin for more detailed coverage of market events. This week, however, with no available power charger on a cross-country flight, HAI is facing seriously limited laptop lifetime. In eventful times, let’s see what we can cover in about an hour of remaining battery life.

While this week wasn’t a big-picture game changer in any sense, it offered hints that the recent no-landing narrative may be getting stretched thin.

Fed Chair Powell is clearly in a pickle, even if the market isn’t yet acting like it. As Nick Timiraos of the Wall Street Journal put it, “Federal Reserve Chair Jerome Powell finds himself in a place no central banker wants to be: working to avert a credit crunch, which calls for looser monetary policy, while fighting high inflation, which demands the opposite.” While the Fed paused and opted not to hike interest rates at last week’s Fed FOMC meeting, this week, in public testimony before Congress, Powell made it fairly clear that the “pause” is temporary. He doubled down rather than walk back his hawkish message of last week. 

Powell seems increasingly inclined to veer policy back toward the recently reinvigorated global central bank tightening spree. Over the last two weeks, the Fed’s pause has been the exception to the global central bank tightening rule. Australia and Canada both resumed rate hikes after having paused previously. Norway, Switzerland, and the ECB also raised rates, and the UK upsized its 13th consecutive hike to 50 basis points.

Powell told Congress “It will be appropriate to raise rates again this year.” He added that officials’ median projection of two more rate increases this year “is a pretty good guess of what will happen if the economy performs as expected.” In other words, if inflation remains sticky-high (which it likely will, as base effects turn unfavorable past July), bank problems don’t resurface (unlikely unless the Fed cuts rates), the tightening of credit doesn’t bite too hard (doubtful), and recession is delayed (also doubtful unless the Fed totally capitulates on the inflation fight), then the Fed will maintain a higher-rates-for-longer strategy. Unfortunately, that higher-for-longer strategy greatly increases the odds of a severely hard-landing scenario for stocks and the economy.

So far in 2023 the market has been trading as if goldilocks perfection is assured in perpetuity: interest rates will be perfect, no recession will hit, bank problems are over, and a feared credit tightening is much ado about nothing. In reality, however, the promised second half 2023 credit crunch has not been cancelled; rumors to that effect have been greatly exaggerated. A recent Financial Times headline is telling: “US junk loan defaults surge as higher interest rates start to bite.” HAI believes the FT headline is indicative of where a global central bank strategy of “higher for longer until something breaks” is headed. Government intervention can certainly interfere (and create a whole new set of complicating factors at any point) but for now, the assumption remains that a bubble market is walking into a buzz saw until economic and market pain is ratcheted up enough to warrant a substantial central bank easing cycle. 

We are not there yet. While markets are dismissing the possibility, odds are strong that we have an “event” ahead of us. It’s a probability thing, of course; nothing is ever certain in markets. What is certain is that in the context of the current set-up, interested parties should hold enough cash to be able to take advantage of a high-odds/high-impact risk-off moment in markets as we creep towards the second half of 2023. At the same time, in this unique environment, current wealth preservation strategies in physical gold may rapidly be approaching a wealth creation opportunity in gold stocks. When current broad market complacency turns cautious again, gold is likely to confirm its breakout higher. That’s the likely trigger for a much more substantial gold mining stock breakout that’s been decades in the making.

Weekly performance: The S&P 500 was down 1.39%. Gold shed 2.11%, silver was hit by 7.38%, platinum lost 6.44%, and palladium was rocked by 9.69%. The HUI gold miners index was abused, down 4.76%. The IFRA iShares US Infrastructure ETF was down 2.16%. Energy commodities were volatile and mixed on the week. WTI crude oil lost 3.85%, while natural gas gained 8.10%. The CRB Commodity Index was down 2.97%, and copper lost 2.31%. The Dow Jones US Specialty Real Estate Investment Trust Index was down 3.72% on the week, while the Vanguard Utilities ETF was down 2.77%. The dollar rebounded, and was up 0.69% to close at 102.54. The yield on the 10-yr Treasury was down 3 bps, ending the week at 3.74%.

Have a wonderful weekend!

Best Regards,

Morgan Lewis
Investment Strategist & Co-Portfolio Manager

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