This episode reveals a market stretched to its limits, where extreme complacency and bullish positioning clash with rising inflation signals and political pressure, setting the stage for a potential 10-15% correction.
Inflation Data and the Fed's Dilemma
- Core Goods & Services: Core goods inflation is running above 1% annually, but the main surprise came from services inflation, which showed signs of reacceleration.
- Month-over-Month Trends: The month-over-month core CPI reading was the highest since January, indicating a potential shift from the recent disinflationary trend.
- Market Expectations: Despite these signals, the market still prices an 89% chance of a rate cut in September, reflecting a strong belief that the Federal Reserve will ease policy regardless of the data. This sets up a potential conflict between market hopes and economic reality.
A Market Primed for Volatility, Not a Crash
- The "Goldilocks" Summer: Johnson notes that while inflation data hasn't been excessively hot, it also hasn't been weak. This has suppressed volatility and pushed asset prices higher on the expectation of imminent rate cuts.
- Rate Cut Uncertainty: He questions the narrative that rate cuts are a guaranteed positive for markets. If the Fed cuts while assets are at all-time highs, it could signal they see underlying economic weakness the market is missing.
- The Long End's Reaction: A cut in short-term rates may not translate to lower long-term rates like mortgages. Instead, the long end of the yield curve could rise on inflation fears, counteracting the intended stimulus. Brent states, “I'm not convinced that if they do cut, it's necessarily going to be welcomed by the market.”
The Political Pressure Cooker: Trump vs. Powell
- The "Fall Guy" Strategy: Brent Johnson observes that Trump has masterfully positioned Powell to take the blame for any market downturn. If Powell doesn't cut and the market falls, it's his fault. If he cuts late and the market falls, it's also his fault.
- Merging Treasury and Fed: The speakers discuss a longer-term trend where the functions of the U.S. Treasury and the Federal Reserve could effectively merge, giving the executive branch more direct control over monetary policy. This shift would have profound implications for central bank independence and asset prices.
- A Politically Acceptable Correction: Johnson speculates that the Trump administration might not be opposed to a 10-15% market correction now, as it would be preferable to a larger crisis closer to the midterm elections.
Warning Signs: Complacency and Stretched Positioning
- Record-Low Volatility: The MOVE Index, which measures bond market volatility, is at an all-time low. Equity volatility is also extremely suppressed, with 10-day realized volatility below 10 for the first time, encouraging systematic funds to increase leverage.
- Tight Credit Spreads: High-yield credit spreads are extremely tight, indicating a high appetite for risk and pushing capital into speculative assets like crypto altcoins.
- Extreme Long Positioning: CTAs (Commodity Trading Advisors), which are large trend-following funds, are 95% long equities. Brent notes, “If the trend followers are 95% long, what does that say about everybody else that they're following?”
- Momentum Divergence: Technical indicators show a divergence between the S&P 500's price, which is near its highs, and momentum indicators like stochastics, which are rolling over. This often precedes a price correction.
The Counter-Argument: "Full Ponzi Mode" and M2 Growth
- M2 Money Supply Reacceleration: M2, a broad measure of the money supply created primarily through bank credit extension, is growing at nearly 5% year-over-year. This expansion of money is a powerful tailwind for asset prices.
- Inelastic Demand: A combination of corporate buybacks and passive investment flows creates a consistent bid for equities, cushioning downturns and driving the market higher over time.
- The Commercial Real Estate Crisis: A severe crisis in commercial real estate, with properties seeing haircuts of over 80%, may force the government's hand to inject massive liquidity and lower rates to prevent systemic contagion.
The Dollar Milkshake Theory in a Changing World
- Relative Strength: Even if U.S. interest rates fall, they may remain attractive relative to the rest of the world. A falling dollar would boost the euro, hurting European exports and creating economic problems there, reinforcing the dollar's relative appeal.
- Overt U.S. Influence: The U.S. is becoming more overt in dictating monetary and trade policy to other nations, demonstrating its continued global power.
- The Fiat Debasement Game: All major economies are expanding their monetary base, leading to the debasement of all fiat currencies. This reinforces the long-term case for hard assets like gold and crypto.
The AI Productivity Boom and Its Social Consequences
- The AI Space Race: The U.S. government is implicitly committed to winning the AI race against China, which will drive investment and innovation. This technological boom could lead to a massive surge in productivity.
- Disinflationary Pressure: AI-driven productivity could eventually cause inflation to fall sharply, but this is seen as an exponential, not a linear, process.
- Social Dilemma: While AI promises efficiency, it also threatens widespread job displacement. Quinn points to rising youth unemployment as an early sign of this disruption, which could lead to social unrest and political blowback against the tech sector.
The Rise of the American Empire and Stablecoins
- Stablecoins as a Control Mechanism: Brent Johnson views the rise of stablecoins (digital tokens pegged to a fiat currency like the U.S. dollar) as a strategic move by the U.S. to create a new, controllable payment rail, similar to how it replaced LIBOR with SOFR to gain more control over global finance.
- Centralization vs. Decentralization: The speakers contemplate a future where crises (debt, demographics) lead governments to impose more control, resulting in the "rise of the American Empire" at the expense of individual freedoms and the "fall of the American Republic."
Conclusion
This episode highlights a critical divergence: short-term indicators point to a market ripe for correction, while long-term liquidity dynamics suggest continued asset inflation. Investors and researchers must navigate this tension by considering defensive positioning now while tracking the development of AI and digital dollar infrastructure for future opportunities.
