Heading into the Fed meeting last week, we talked about the contradictory way the Fed has been evaluating trade uncertainty.
In 2019, they saw it as a drag on growth, with deflationary pressures from demand destruction. And they started cutting rates in July of 2019, citing weak foreign growth (particularly in China and the euro area). And over the next four months, they slashed rates a total of 75 basis points, and return to quantitative easing.
This time around, as we discussed last week, we've had plenty of negative data, including weak global demand, yet the Fed has been ignoring it, in favor of what they suspect, might be inflation coming around the corner.
In other words, they've abandoned 'data dependency' and instead have become speculators — betting on inflationary outcome.
Meanwhile, we are now four months into tariffs and the rate-of-change in prices has been falling. They've been wrong.
Moreover, the area you might expect to clearly see the effects of tariffs, import prices, were flat last month. And export prices, are clearly demonstrating that the tariff policies, if anything, are weakening global demand (i.e. demand destruction).
And with that, heading into last week's Fed meeting, we talked about the October 2023 dovish pivot from Jerome Powell — the last time export prices declined at the rate of this past May.
Despite all of this, we didn't get even a hint of dovishness from the Fed last Wednesday.
The markets were then closed for a holiday on Thursday.
And then, before the market opened on Friday, they walked Chris Waller (Fed governor) out in front of a camera (on CNBC) to give a very deliberately placed and worded "expectations reset."
He called for a July rate cut. And he openly admitted the Fed hasn't followed "the data," and instead has been (his words) "on pause for six months thinking that there was going to be a big tariff shock to inflation."
Another Fed voter (Bowman) followed today with similar messaging, favoring a July cut.
This brings us to the voice that matters. Jerome Powell will be on Capitol Hill starting tomorrow morning giving testimony to Congress.
If he sings the same tune, we will have the alignment of some very powerful tailwinds for stocks.
A dovish pivot from Powell would be tailwind number one.
Tailwind number two: Late in the day, Trump proclaimed a ceasefire and end to Israel/Iran war, potentially removing some geopolitical risk premium.
And tailwind number three: Trump thinks the tax bill will be passed by July 4th.
And of course, the biggest tailwind (#4) is the industrial revolution that continues to rapidly advance, yet remains in the early stages.
If we look at the above chart, when Jerome Powell signaled the end of the tightening cycle in October of 2023 (a dovish pivot), both the Russell (small caps) and the Nasdaq (led by big tech) rose over 50% over the next 13 months.
And as you can see, the Russell topped first in late November last year, on the "reflation" fears of Trump policies, and the potential for a shallow easing cycle.
We've since had the Fed pause. And we've had the tariff-fear induced broad sell-off across stocks.
The full V-shaped recovery is nearly complete for the Nasdaq and the S&P 500 (back to record highs). But the Russell has lagged — still 14% away from record highs of last November. A resumption of the easing cycle would be fuel for small caps to catch up.