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A cold shower to the bulls

Matein Khalid

My digital purdah came to an end with a bang and not a whimper as Powell made it clear that it is “very premature to think about a pausing”. This was a cold shower to the bulls and the DJIA went from +350 to -500. What an ouch! The Treasury bond market resumed its bloodbath. Chairman Powell’s message to the Street was precisely what I expected. PCE inflation is 6.2% against the central bank’s target of 2% and thus the pause/pivot/pirouette bulls may as well just drop dead.

My critics call me Dr. Doom but I like to think that I am Dr. Reality and the data on both the hottest job market and the highest core inflation in a generation told me that there is no way Powell was going to announce a pause at the November FOMC, even if housing, used car prices, shipping freight rates and commodities prices have sagged.

CME Fed fund futures now price 60% odds for a 75 basis point rate hike at the December FOMC and a 5% Fed funds rate by Spring 2023. It is wishful thinking to assume that US Treasury bond yields are not going to go higher even as a weaker economy means credit/sovereign bond credit spreads can move a whole lot wider. The overnight borrowing rate for US money center banks is now 3.75 to 4.00% but I do not know anybody who borrows at the Fed funds rate, even though it is at its highest level since the peak of the credit bubble in 2007.

The FOMC statement in plain English tells the markets that there will be more pain to the economy, the labour market, risk assets and collateral damage to a world handcuffed to the destiny of King Dollar since monetary policy must be “sufficiently restrictive to return inflation to 2% over time”. Take it from me, we will not see 2% inflation till at least 2027 since even Paul Volcker’s monetary sledgehammer took 7 years to bring inflation down even as his 20% dollar interest rates caused the housing markets to collapse, the Farm Belt to go bankrupt (truckers blocked the entrance to the Fed’s marble palazzo in DC in a scene reenacted in Brazil as Lula replaces President Bolsoloco), Latin America’s biggest economies to go belly up, tanker rates to tank and crude oil prices to plunge from $45 when HIM Shah of Iran lost his Peacock Throne in 1979 to as low as $8 in 1986 when King Fahad fired Sheikh Yamani. Tight money in the 80’s doomed both the USSR and BCCI.

I am stunned that investors simply do not grasp that inflation cannot return to 2% without the most vicious global recession since the Great Depression of the 1930’s. This means much higher real rates and I thus believe gold can go far lower than my 1560 target to $800 an ounce. After all, gold traded at $296 an ounce in July 1982 as Aerial Sharon’s IDF besieged West Beirut and vaporized 74 Syrian Mig’s over the Bekaa Valley. Amnesia is fatal when the Fed turns nasty and James Joyce was right “history is a nightmare from which I struggle awake” especially if I have seen it enacted before in the green phosphorescent flicker of my Bloomberg screen.

Matein Khalid is Investor | Family Office CIO | Portfolio Strategist | Board Advisor | VC | Finance Professor

Also published on Medium.

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