Of course we’ve had big geopolitical risks along the timeline of this chart, that include an historic trade war (which continues) and potential sanctions against Saudi Arabia (late last year).

The geopolitics have consumed the markets attention. But maybe it’s all about the Fed, and their ability to interpret (or lack thereof) the impact of trade disputes and structural reform in the global economy – and position correctly.

If we look back at the timeline, the tops and bottoms in these V-shaped moves in the chart above all align perfectly with Fed speak.

Stocks topped on October 3rd and proceeded to drop 20% through the end of December.  What happened on October 3rd?  The Fed chair, Jay Powell, did a sit down interview with PBS, where he said, after raising rates three times for the year, that they remain far away from the ‘neutral’ rate.  And he said they may go past neutral. Why?  He thought tariffs and the uptick in wage growth would feed into inflation.  He was wrong.

With that view of tighter and tighter monetary policy into a low inflation and recovering economy, with hurdles of trade reform in the path, the markets started signaling the contra-viewpoint:  the trade war weighs on global growth, and within that context, rising U.S. rates are a killer for emerging market economies, and for the slow recovering developed markets.

Powell’s comments started the decline, which ultimately led to a big decline. Yet, the tone-deaf Fed raised rates in December, again, right into a falling stock market.  Moreover, following the December Fed meeting, the Fed made it clear that they were prepared to mechanically keep raise rates — another four times in 2019.

When did it turn?  It turned the day (January 4th) the Fed marched out Powell, Bernanke and Yellen, (tails between their legs) to tell the world ‘no more rate hikes/ the Fed is done.’

Stocks bottomed, on that day, and did a perfect ‘V’ back to the record highs over the following months.

When did it top again?  May 1.  What happened on May 1?  The Fed met and Jay Powell had his post-meeting press conference.  After months of running Fed officials out in the media to tell us the Fed’s got your back, Powell fumbled.

The interest rate market (10-year yields) had fallen 75 basis points from the highs of just six months prior, giving a very clear message to the Fed that, at the very least, the December hike was a policy mistake.  But Powell was unwilling to show any leaning toward a rate cut. In fact, he said the risks that precipitated their “pause” on the rate path (China and European growth, Brexit risks, and trade negotiations), have been largely improving.  Again, the Fed was tone-deaf and unwilling to take a defensive stance against the unknowns of geopolitical risks.  Stocks go down.

A few days later, U.S./China trade talks come to a standstill.  Stocks continue on for a 7% decline.

When did stocks bottom? June 3rd.  What happened?  A voting Fed member, Jim Bullard said that a Fed cut may be “warranted soon” to “provide some insurance” in case of a sharper slowdown. That was a primer for a June 4th speech by Jay Powell.  Powell came out of the gates, in a prepared speech that morning, telling us they “will act as appropriate to sustain the expansion.” That spurred the second “V-shaped recovery” on the above chart.

The conversation at the Fed has now, finally, turned to rate cuts.  And the market is now expecting a 100% chance the Fed will cut at the July 31 meeting.

Perhaps now the Fed is in the right position, trade deal or no trade deal. And that should be very good for stocks.

Remember, the last time the Fed was in this position in 1994, they cut rates and that led to a huge year for stocks — and stocks and the economy boomed through the end of the nineties.

Remember, this first run-up had everything money moving out of China, and less to do with Silicon Valley genius/ global monetary system disruption.

In late 2016, with rapid expansion of credit in China, growing non-performing loans, a soft economy and the prospects of a Trump administration that could put pressure on China trade, capital was moving aggressively out of China.  That’s when the government stepped UP capital controls — better policing movement of capital out of China, from transfers to foreign investment (individuals can move just $50,000 out of the country a year).

Of course, resourceful Chinese still found ways to move money.  Among them, buying Bitcoin. And that’s when Bitcoin started to really move (from sub-$1,000). China cryptocurrency exchanges were said to account for 90% of global bitcoin trading. Capital flows were confused with Silicon Valley genius.

But in September of last year China crackdown on Bitcoin – with a total ban.  A few months later, Bitcoin futures launched, which gave hedge funds a liquid way to short the madness. Bitcoin topped the day the futures contract launched.  And a few months later it was worth 1/6th of its value at the top.

Is this time different?  Is this real traction for Bitcoin, or is this just Chinese capital flows looking for a parking place, again?  Likely, the latter.  It’s probably no coincidence that as the prospects of a ‘no deal’ with China have elevated in recent months, Bitcoin has again been on the move.  As we’ve discussed, if Trump holds firm on his demands, it seems impossible that China can do his deal.  It’s political suicide for the Chinese Communist Party.  With that, they fight tariffs with a devaluation of the yuan.

With those prospects, if you have money in China, you have been getting it out!  While cryptocurrency exchanges have been banned in China, owning and buying Bitcoin in China is not banned.  The Bitcoin futures market and off-exchange (peer-to-peer) trading are liquidity sources for Chinese citizens to respond to potential devaluation in the yuan.

With the above in mind, this round of Bitcoin bubble may not deflate until/unless Trump makes concessions to do a deal (which seems unlikely until, at least, we get past the July Fed meeting).

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As we’ve discussed for much of the year, what else is similar between the current and 1994-1995 period?  We had an overly aggressive Fed, that tightened into a low inflation, recovering economy.  In 1995, they did an about face, cutting rates at their July meeting.  And now we head into the July Fed meeting with expectations of a 50bps cut.

On that note, we heard from the Fed just days ago, signaling that they were ready to act if conditions deteriorated.  And as I said following the meeting: “What is clear, from Powell’s press conference, is that this is all about the China trade deal.  If it drags out, sentiment continues to erode.  When sentiment erodes, the economic momentum will erode.  If that’s the case, they will be reactive, with stimulus (rate cuts and/or slowing the runoff of Treasuries on the Fed balance sheet).”

Today, Jerome Powell was again on a stage talking about monetary policy, at a conference on the Economic Outlook and Monetary Policy at the Council on Foreign Relations.  He had a prepared speech and did a Q&A.  So what message was he trying to send to markets?

He did a lot of talking.  But I suspect his posturing doesn’t matter at this point. This less about him, or the economy, and more about Trump.  If Trump were to back off the hardline demands and signal a deal with China over the weekend, the Fed would be off the hook — no rate cut.  If the meeting comes and goes, and it’s a clear kick the can down the road, or no deal –we get a cut by the Fed come July (whatever size and scope is necessary).

So what is gold telling us?  Gold is the bet that the trade war won’t be resolved.  And that, along with the sharp decline in global government bond yields this year, is telling us that global central banks will be forced back into highly stimulative policy.

Will it happen?  With all of the scenarios that strategists are conjuring up, looking for potential cracks in the economy, it really boils down to “what will Trump do?”  If he holds firm on demands of China, then the markets are right (pricing in economic slowdown, deflationary pressures, aggressive monetary stimulus and maybe military war).  If he folds/ concedes to get a deal done.  The markets are wrong.

In either case, in the near term, ultra-low rates and the prospect of more monetary stimulus is fuel for stocks.   And if the trade war were to end with a deal, the stocks would have the tailwinds of low rates and an economy that would probably pop to 4% growth.