Watering The Fed Hike Plant, Market Risk

| About: SPDR S&P (SPY)

Summary

Bonds look like they can never, ever go down again.

We think the success of bonds, credit spreads, and stock divergence will depend on one thing.

That thing is inflation.

We worry about markets ahead of the Fed meeting if there is any whisper (this time) about inflation.

You never knew Fed FOMC analysis could be so much fun.

With the Fed meeting today, it appears clear that they'll raise... their language (but not rates) for a rate hike in September. Jobs bounced back after the strike. But are jobs the issue that has the Fed itching to raise, or is it inflation? There is a huge difference here, and it could be the deciding factor as to whether this tiny-yield high-equity trade continues.

We wrote that the Wall Street Journal ("WSJ") article was likely a Fed plant to say that a rate hike was "on the table" for September.

(Picture: Here's one of the Fed's plants that the WSJ was talking about. Alongside the main Fed plant are other Fed plants. We're not sure which one they bring to this week's meeting. We of course remember old photos of past Fed chairs carrying all sorts of things, like piles of papers.)

We wrote that the Fed appeared to want to warn for a rate hike for the September meeting, and they may put that somehow in their 2 PM release.

The September Fed futures haven't budged much and stand at a 78% chance that rates stay the same.

Here's the chart to say most don't believe the Fed will do anything, even in September.

Click to enlarge

The above chart is calculated by taking 100 minus the expected rate in September. 99.58 means an expectation of a 42 bp Fed funds. Currently, rates are at 25-50bp so roughly in line with current rates.

We expect this chart to spike downward on the FOMC announcement. We expect that can hit markets.

But the driver for that rate hike will be what determines the market's (NYSEARCA:SPY) direction medium term.

What really matters now is what wins - growth or inflation. We've been saying that we expect inflation wins over growth. We think inflation, not growth, will be the reason that the Fed will raise rates (don't glaze over - this is important).

Inflation is the real reason the Fed wants to raise.

We think growth is slowing and the jobs numbers are an excuse. Inflation is the real reason they want to raise.

Why do we think that? Because growth is slowing and inflation is picking up. Not so difficult. We ask you, why would the Fed ever want to raise rates because growth is slowing?

Here's the jobs number.

Click to enlarge

May saw a strike and Verizon (NYSE:VZ) came back from that strike in June. So we average the two months to 149k. 149k is about even with 144k, but is slower than at any time in the last year. That is... slowing.

Now let's look at GDP. Which way is this going?

Click to enlarge

Which way is GDP going? It is... slowing. Very nice.

So growth is slowing. Is that fair? Even the monster jobs number was a slower number. Monster = slower. (Not such a scary monster.)

Now Let's Look At Inflation

Please oh please, tell me which way the Fed (let's look through the Fed's eyes now) sees inflation going.

Here is the main Fed inflation measure.

Now before you look at this next chart, I want you to scroll back up to have the jobs and the GDP charts in your head. I want you to see the trajectory of those two charts. Until you do that, you cannot look at this next chart. I'm sorry, I won't allow it.

You scrolled up? You looked? It's in your mind? Great.

Now please look at this next chart. Remember, this is the Fed's core inflation measure. This is the main one.

Click to enlarge

A couple of quick questions, okay?

Which way is this chart going? Up, right? It was sitting, now it's standing upright.

Which way are the GDP and jobs charts going? Down, right?

OK, you're the Fed. Okay? You're in that meeting. Here are the three charts on the table. If you raise rates, you raise rates because...

A) That cactus pricked you

B) Jobs are slowing

or

C) Inflation is JAMMING HIGHER?

If we were the Fed, we'd have to choose C, fair?

Let's wander over to their last FOMC meeting, okay?

This will be fun. Go with me here. (Elazar groupies know a "go with me" is always as action packed as you are going to ever get in any snoozy snorey boring Fed financial expectation report.)

Go with me here.

Click this link, please, in another tab (Not sure you can do that - you may need to save this link first then click this link).

Got it? Great. Have a piece of paper and a pen ready.

Great. This link you see is dated June 15th, their last meeting.

Now go to that link and search GDP. You'll see 2016 at 2%. What did it say it was in March (just below it)? 2.2% right? Is that slower or faster? 2% is slower than 2.2%, right? Great. So, growth is slowing like we showed in the charts above. The Fed expects it to slow.

Now go to that link and search PCE. You'll see 2016 1.4% and if you click "enter" again you'll see 1.7%, that is for 2016. What did it say for March? 1.4% in June was 1.2% in March. 1.7% in June was 1.6% in March.

The Fed said in that meeting growth is slowing and inflation is picking up. You remember them saying that? I don't. That's because they didn't mention inflation.

Total sweep inflation under the rug rating.

This is going to be tough to sweep under the rug for very long. Just for fun, let's look at that PCE chart again. (I'm willing to bet that NEVER in your wildest dreams did you ever think that you would be looking at a PCE chart for fun. Here's a first.)

Now let's look at PCE for fun.

Click to enlarge

I hope SA allows me to put the same chart twice, but it is just so critical and we think people are dreaming about ATH and missing PCE.

Conclusion

I promised you a good "go with me" right? Hope you enjoyed that one.

Growth is slowing and inflation is picking up. The Fed expected it.

The globe is slowing. (Global warming guys, don't worry. The global rotation is the same speed, I think. It's the global GDP that's slowing.) G-20, ECB, JCB, IMF, IEA, OECD, IKEA, and ABCD, are all saying slowing. And so is the Fed (last meeting's numbers which you didn't hear about).

And they want to raise... we think because? Inflation (not because of slowing GDP).

That is not good for bond yields, bond prices, bond credit spreads, and in the end, it's not good for equities either. Why? Because inflation will drive up rates without growth. We think that could be the itch in the Fed head.

We're bearish.

Please be safe.

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Disclosure: I am/we are short SPY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.