Stanley Druckenmiller once said that as “an economy reaches a certain level of acceleration… the Fed is no longer with you… The Fed, instead of trying to get the economy moving, reverts to acting like the central bankers they are and starts worrying about inflation and things getting too hot. So it tries to cool things off… shrinking liquidity…”
This is where we are now. A classic late cycle environment.
The Fed stated loud and clear that they’re happy with where the economy and plan continue on full-steam ahead with rates hikes and quantitative tightening.
This doesn’t mean a recession or bear market is around the corner. In fact, we probably have another 12-18m of upside (barring a material escalation of the trade war) here in the US. But it does mean that we should expect the Fed to execute on their projected median rate path and that it’s unlikely they’ll slow down in response to market volatility.
And we should expect more volatility… especially in emerging markets. This is because the Fed is about to start pulling large amounts of global liquidity.
When you combine the Fed’s quantitative tightening (QT) with the increased treasury issuance stemming from the rising deficit, you get roughly $2 trillion in extra treasury supply that’s going to have to be absorbed by the market. These dollars will have to come from somewhere and that somewhere, has so far been the USD denominated emerging market debt market.
Throw in higher U.S. interest rates and it’s tough to see how emerging markets find a way out of this tightening liquidity vice.
To learn more, make sure you watch the video above!
And as always, stay Fallible out there investors!
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