The Fed on hold and no shocks from H2 2016, unless Trump gets in!

I was asked what H2 looked like for the US economy. That is quite a question, but comes with a simple answer - slightly better than H1, but a whole lot better that 2017, 2018 and the foreseeable future.

For many years I have been bearish on the US economy and the dollar. That does not mean that I did not think the stock market could not continue rising to all-time highs though, nor would the US dollar and denominated assets attract investment while global rates are close to zero elsewhere, even negative in some areas of the market's instruments. The US stock market is, after all, like what the housing market is to the UK economy and consumer confidence and both are in a serious bubble that many are not seeing. However, so long as there is more air in the lungs of the markets, fuelled by Central Bankers bicycle pumps, there is no impending reason for it to pop - not just yet anyway. 

The Federal Reserve have manipulated the markets higher ever since the Subprime Mortgage Market Collapse in 2007 and subsequent default federal takeover of Fannie Mae and Freddie Mac in September 2008. This was just one of the many events of the global financial crisis that included the default of major institutions such as the fourth-largest investment bank in the United States behind Goldman Sachs, Morgan Stanley, and Merrill Lynch, namely, Lehman Brothers. The financial services firm had been operational for 158 years from its founding in 1850 until 2008 filed for Chapter 11 bankruptcy protection due to the massive exodus of most of its clients, drastic losses in its stock, and devaluation of assets by credit rating agencies, largely sparked by Lehman's involvement in the subprime mortgage crisis and subsequent allegations of negligence and malfeasance. This was the first of many major institutions to fall for lots of the same type of negligence and often spurious activity amongst the boards of such firms. 

We all know the story, so no point dwelling on the past - or is there?

Don't worry, crash not coming just yet, US economy H2 looks robust on face of decaying body, but elections are not usually good for Wall Street

Before I ruin your day, if you are a U.S. citizen reading this, let's not be too hard on the outlook, for H2 at least. Q2 has been far better that Q1 (not that is saying much as Q1 was so poor) and we are starting to see a rebound in headline data at least, such as the recent nonfarm payrolls. The Fed is on hold still and we have seen a subsequent rally on Wall street, all pointing to an increase in consumer confidence which is, at the end of the day, the engine of the US economy. However, and besides the real problems that America's economy is facing, it is a presidential election year and historically, that has never been good for US markets. 

Since 1900, the S&P has usually fallen in the last year of the 8-year presidential term and most of the time, the president starts their term with the US economy either in a technical recession or very close to it. The worst decline in the stock markets was during George W. Bush's last term, in 2008, when the market fell by about 41 percent. However, this is a whole other matter and will only distract us from what the real matter at hand. 

Whistling while walking past the graveyard

For a long time now, it has been like walking past a graveyard whistling, ignoring the devolution in the US economy due to the Fed's medicine, like heroin to a drug addict, but this is only making the addiction worse and the patient (economy) sicker, leading to their impending death. I apologize, if that is not nice to read, but it is a fact of life and all parties have to end at some point; indeed it looks like the Fed will have to take away the punch bowl at some point in time, perhaps once these elections are out of the way, 2017 really starts to kick in and after a period of trying to keep the patient (US economy) alive on a life support machine ( more QE), even though they know it will only appease the relatives (China and US creditors) for so long before they too give up hope and finally pull the plug of the US economies life support machine. However, like I said, we have had a better Q2 in H1 which should, in theory, support a positive outlook for H2.

The Fed's position for H2, stuck in the mud, return of infinity QE in 2017

The Federal Reserve have raised rates just once since Sep the 17th 2007 when rates were cut from 5.25% to 4.75% at the start of Bernanke's easing zero interest rate policy in the height of the financial crisis when he was announcing his rescue plans for the US and global economy.  Rates continued to drop to ultimately support consumer demand  and jobs creation until Sep16th 2008's final cut to 0.0% - 0.25%. From November 2010 until December 2013, Bernanke also implemented a number of additional supporting and complicated measures to support a recovery, known as QE2 and 3 and 2011's Operation Twist, ( as attempt to do what QE2 had achieved, but without printing more money or expanding the Fed's balance sheet, therefore to try and avoid the inflationary pressure associated with QE2, and QE3 has done). The tapering of such inflationary type programmes finally ended on October 2014 with a sigh of relief. On December 17th, 2015, the Fed finally increased rates by 0.25% to 0.25%-0.50%. 

However, at the time, markets had wondered why the Fed would even bother to raise rates, as it seemed that the U.S. economy was not in recovery by any shape and it was if they did so to simply save face, this time under the stewardship of Yellen who had been appointed after previously serving as Vice-Chair from 2010 to 2014. OnJanuary 6th, she was nominated and subsequently sworn in on February 3rd, 2014, making her the first woman to hold the position. She started out her role considered as a dove by Wall Street. Yellen, as a Keynesian economist who advocates the use of monetary policy in stabilizing economic activity over business cycles, believes in the modern version of the Phillips curve (which originally was an observation about an inverse relationship between unemployment and inflation). The modern version of the Phillips curve model relates the movements in inflation to the degree of slack in the economy and she has thus been "concentrating" on steering the US economy to its inflation target of 2%. 

However, I'm not so sure that this 2% target is anything more than an excuse to turn the printing machines back on. After all, who says that consumers are going to sit on their hands until prices start rising, because otherwise, they would prefer to wait for a bargain in an environment of falling prices? That logic doesn't make sense to me - as once a proud owner of an iPhone, I seem to recall queuing up until my number had been called out "number 280" at just 11am due to customers piling up to buy their new iPhone and accessories at bargain prices each time new and far more expensive models (not much more advanced mind you) were released.

Anyway, in respect to the Fed in H2, I don't see a rate hike coming and not just because of the elections. I actually believe that the Fed is behind the curve and headed negative

"The reality is, the Fed want to keep rates artificially low, masquerading as if they want to normalise them," is what I wrote back on June 8th. "Even though they had raised rates in December, well real rates are even lower than where they were before due to the inflation that exists in the economy which has been increasing more than the Fed are increasing rates and more than the official inflation numbers tell. So real rates have actually gone down. Even if they do hike again, by say another 0.25% in September or 2016, year over year inflation could well be more than 0.25% by then leaving the Fed behind the curve still. Negative rates here we come."

S&P500 2-year daily chart

I stand by that argument still of course, and although there have been slight improvements in headline data since, it is still very early days. The stock market is in a huge and artificially inflated bubble (between 80% to lower end 50% overly inflated perhaps, just like in 1929 and 1999!) and will likely remain so throughout H2, especially as rates will not be going up, consumers will therefore remain confident and 'business as usual'. However, there are plenty out there warning of doomsday. Even the Royal Bank of Scotland famously warned its clients that the markets are flashing stress alerts akin to the 2008 crisis. “Sell Everything” because “in a crowded hall, the exit doors are small,” they said. 

The charts tell a thousand words

There are a number of Wall Street charts that should be monitored, all showing exhaustion and gap island reversal style patterns. Fundamentally, earnings are collapsing in the US corporate sector and bearish bets continue to mount around the value of the US dollar in fact. However, just for now, while the Fed can't raise rates, I'm not betting on a bad H2 in the US economy, but I do advocate buying gold and I do warn of bad years ahead should the Fed either attempt to raise rates and fail, worst case scenario, or simply go back to infinitive QE or negative rates before having to actually raise rates without having a choice. Rates will have to rise at some point and the longer they delay doing so, the harder the landing will be.

XAUUSD 1-year daily chart

 

Hiding behind Brexit

I have not mentioned the risks of a Brexit until here, because for now, this is not an actual event that has taken or will take place, if at all, or for a long time to come. However, given markets are always thinking ahead and subsequent risk-off activity on the referendum's outcome, of course for now at least, it is just an excuse that the Fed can hide behind as a reason not to hike rates. 

The 'Trump' factor

I am divided on Trump. He is either going to be the world's saviour or the very person and event to start World War three. If he is elected, I think the markets are going to be equally divided and volatile. His stance on immigration, whether it is right or wrong, with the US that relies on so much consumer lead demand and that thrives on immigration, cheap labour and travel, the economy could be put under severe pressure, leading to investors getting short of the US economy and US dollar in the near term.