Stocks, Bonds, Gold, Bitcoin and the US Dollar: No Place to Hide?

Key Concepts

• Market Panic: Widespread selling across asset classes (stocks, dollar, bonds, crypto).
• US Government Shutdown: The longest on record, its resolution initially boosted markets but was overshadowed by other concerns.
• Federal Reserve (Fed) Policy: Uncertainty surrounding potential interest rate cuts, particularly in December.
• Economic Data Fog: The shutdown's impact on the availability and reliability of economic data, hindering the Fed's decision-making.
• Risk Sentiment: A general aversion to risk, leading to selling of riskier assets.
• Haven Assets: Assets traditionally considered safe during market turmoil (e.g., gold, certain currencies), but their performance was mixed.
• Fed Funds Futures: Market-based indicators reflecting expectations for future Fed interest rate decisions.
• Summary of Economic Projections (SEP): The Fed's official forecast for economic conditions and monetary policy.
• Dot Plot: A graphical representation within the SEP showing individual FOMC members' projections for the federal funds rate.
• Speculative Appetite: The willingness of investors to take on risk for potential gains.
• Retrenchment: A reduction in investment exposure.

Market Performance and Initial Reaction

The markets experienced a significant sell-off, described as a "bloodbath," with stocks, the dollar, bonds, and crypto all declining. This occurred as the US government reopened after its longest-ever shutdown. The presenter, I.A. Spac, head of Global Macro at Tasty Live, notes the unusual situation where traditional haven assets were also being sold, making it difficult to identify a clear defensive venue.

Specific Market Movements (ahead of close):

• S&P 500: Down 1.7%
• NASDAQ: Down over 2%
• 10-year Treasury yield: Up (bond prices down)
• 2-year Treasury yield: Up (bond prices down)
• Crude oil: Idling
• Gold: Down 0.7%
• US Dollar: Down
• Euro: Up
• Yen: Up
• Bitcoin: Down 3% (less aggressive than expected given NASDAQ's decline)

Two Distinct Market Movements This Week

The week's market performance can be broadly divided into two phases:

1. Monday: A "rosy" day with stocks, yields, crude oil, and gold all up. The dollar was stable, and Bitcoin saw a modest rise of over 2%. This optimism was driven by the expectation that a deal to end the government shutdown would be passed and signed.
2. Tuesday to Present: A reversal of the Monday rally. Stocks and Bitcoin (acting more typically as a risk asset) declined significantly. Yields saw a slight increase, crude oil dipped, and gold, while still up on net for the week, was "soggy" on the day. The Euro and Yen gained against the dollar, though the dollar held up better against the Yen than most other currencies, with the exception of the Australian Dollar, which rallied overnight on a positive jobs report before succumbing to risk aversion. The Canadian Dollar also saw the greenback advance slightly.

The Underlying Concern: Fed Policy and Economic Data

The presenter argues that the market's initial relief over the shutdown ending was short-lived because the primary concern coming into the week was not the shutdown itself, but rather the Federal Reserve's (Fed) monetary policy.

• Fed Chair Jerome Powell's October Statement: Following the October 29th meeting, Powell's press conference "hit like a bulldozer," signaling that a December rate cut was far from a foregone conclusion. This statement significantly impacted market expectations.
• Market Reckoning: The sell-off observed this week is seen as a "reckoning" on Powell's comments. Stocks and Bitcoin declined, yields were nursing gains from the prior week, and gold rose after a significant sell-off. Currencies like the Euro and Yen held up after taking "big haircuts" against the dollar, suggesting risk was catching up to what bonds and currencies had already priced in.

Fed Funds Futures and Policy Ambiguity

The "new math" from Fed Funds Futures highlights the market's confusion regarding the Fed's next move.

• Current Expectation: The likelihood of a December rate cut is now a "50-50 coin toss" (just over 50% for a cut, 48.5% against).
• Shift in Expectations: A month ago, the probability of a cut was 95%. A week ago, it was 70%. Yesterday, it was around 63-64%. This indicates a "relentless decline" in the market's conviction that the Fed will cut rates.
• Impact of Shutdown Ending: While the end of the shutdown was expected to provide the Fed with more economic data, the administration's statements suggest that crucial data (like October CPI, unemployment rate, and potentially PPI) may be delayed or unavailable. This exacerbates the "tremendous amount of fog" the Fed is operating under.

The Fed's Dilemma: Conflicting Forces and Data Scarcity

The Fed is facing a difficult situation due to conflicting economic forces and a lack of clear data.

• Powell's October Concerns: Powell had already expressed concerns about the conflicting forces in the economy, particularly the softening labor market, which led to the September and October rate cuts.
• Data Dependency: The Fed's ability to make informed policy decisions is hampered by the shutdown's impact on economic data. The hope was that the reopening would lead to a "flood of economic data" that would clarify the outlook for the December meeting and the subsequent Summary of Economic Projections (SEP). However, the administration's pronouncements suggest this data will not be robust.
• Market Interpretation: The markets appear to be interpreting this ambiguity as a sign that the Fed itself is unsure of its next steps. This uncertainty is leading to a sell-off as investors become uncomfortable making bets.

Why the Dollar Isn't Acting as a Haven

The current market environment is not behaving like a typical "risk-off" scenario where the dollar would strengthen.

• Dollar's Performance: The dollar is not benefiting from the expectation of tighter monetary conditions (fewer rate cuts) nor from the risk aversion.
• Absence of "Sell America" Vibe: Unlike previous periods of uncertainty (e.g., late March/early April), there is no widespread selling of US bonds or soaring gold prices, which would indicate a loss of confidence in the US sovereign or dollar. Bonds are trading within their recent ranges, and gold is down.

The "Fog" as the Primary Driver

The presenter concludes that the current market action is primarily a reflection of the "fog" surrounding Fed policy expectations, which have become a "50-50 coin toss." The markets are essentially "channeling what they think Fed officials think," which is a state of uncertainty due to the lack of economic data.

Speculative Appetite Hitting a Wall

The current sell-off is characterized by a general "retrenchment" from speculative exposure across all asset classes. Anything that had seen gains over the past three months – stocks, bonds, the dollar, and gold – is now being sold. Investors are expressing discomfort with making bets in an uncertain environment.

Fed's Summary of Economic Projections (SEP) vs. Market Expectations

The SEP from September provides a baseline for understanding the Fed's outlook and how it contrasts with market expectations.

• September SEP: Forecasted three rate cuts for the year (though this was narrowly driven by a dovish dot from Governor Steven Mnuchin). Only one cut was projected for the following year.
• Market Expectations for Next Year: Markets are pricing in approximately 66 basis points of cuts for next year, implying at least two 25-basis-point cuts, with a better than 50/50 chance of a third. This suggests markets believe the Fed will need to be more accommodative than its current projections indicate.

Persistent Ambiguity and Potential for Further Shutdowns

The short-term continuing resolution to reopen the government could lead to another shutdown in January, further derailing economic data and prolonging the ambiguity surrounding Fed policy. This lack of clarity is detrimental to market sentiment.

Post-October Fed Meeting Market Action

The market's reaction since the October Fed meeting, where Powell's press conference caused a significant shift, is evident:

• Stocks: Have not made new highs and have been consolidating or declining.
• Dollar: Was rallying even as rate cuts occurred, but sentiment has turned due to ambiguity. The dollar is selling off after a prior uptrend.
• Gold: Had a run-up but has stalled.
• Bonds: Despite pulling back since late October, the trend has favored gains over the past several months.

Conclusion: "If the Fed Doesn't Know, We Don't Know"

The overarching theme is that the markets are mirroring the Fed's uncertainty. The phrase "if the Fed doesn't know, then we don't know" encapsulates the current sentiment, leading to a reduction in exposure and a general backing away from risk.

Presenter's Portfolio Adjustments

I.A. Spac details recent adjustments to his portfolio:

• Silver: Took profits as it hit a wall and speculative dynamics suggested a pullback.
• Dollar Exposure:
  • Peeled off long dollar exposure against the Canadian Dollar and Australian Dollar earlier in the week.
  • Flipped short positions in the Pound and Euro to long, though not fully.
  • Still short the Yen on the spot side, as it hasn't moved as much as other currencies.
  • Overall dollar exposure is now "evened out."
• Risk Exposure: Remains "very much short risk," with existing puts in Bitcoin and the S&P 500 (initiated around the October Fed announcement).
  • Bitcoin spread held for almost 1.5-2 months.
  • SPY puts held for about two weeks.
• Bonds: Still holding the long end of the bond market, acknowledging they are not working today but also not falling apart.
• Crude Oil: Shorting a small amount, noting its narrow bounce today after a significant sell-off yesterday.

The presenter plans to continue monitoring these positions and will be on air on Tasty Live for further analysis.