Ignore the Headlines Today, the Fed is Cornered.,

The entire world is waiting to see what the Fed will announce today.

Will the Fed raise rates? Will it not? Will it mention shrinking its balance sheet? Will it not?

At the end of the day, in the longer term, it doesn’t matter. Sure, whatever the Fed decides to do today will matter for a few days. But after that, things will be right back where they were to begin with.

You see, the current market cycle is markedly different from the last two.

The last two market cycles followed a clear pattern:

  1. A bubble appears.
  2. The Fed ignores the bubble for far too long.
  3. The Fed finally acts to burst the bubble by tightening monetary policy.
  4. The bubble bursts, the markets crash, and the Fed introduces extraordinary monetary policy.

This time around, we have the following situation:

  1. Inflation is in the financial system.
  2. The Fed has only just stopped easing monetary conditions.
  3. The bubble is already bursting.

In this sense, the Fed is cornered.

If it DOESN’T aggressively tighten monetary policy, inflation will trigger a recession (consumer spending is 75% of the economy), which will trigger a stock market crash.

If the Fed DOES aggressively tighten monetary policy to kill inflation, the markets will experience a credit event as the trillions of dollars’ worth of debt that rely on ultralow interest rates blows up.

There are over $10 trillion in corporate bonds outstanding. And high yield corporate bonds have already retraced ALL of their post-Covid-19 gains.

Put another way, the Fed is screwed no matter what it does. If it moves to kill inflation it blows up the debt markets. And if it ignores inflation or acts too slowly to stop it, the economy collapses.

On some level the markets know this. Take a look at the below chart and you’ll see what I mean.

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