Iām back with another Milk Road Macro PRO report - and itās a big one.
This is where we take a very wide birdās-eye view of the most important factors driving markets.
Itās basically been ārisk-onā since April - and animal spirits are alive and well.
Iāll show you why things are still looking good for more upside - thereās no need to panic.
However, there are a number of important things to watch carefully for potential shifts in markets.
Weāll look at:
- Why the Fedās ārun it hotā policy is important
- The historic stock market melt-up (and why itās the āmost hated rally everā)
- The evolving liquidity picture
- How financial conditions are powering markets
- Where we are in the business cycle
- Why the US economy is looking great (sorry doomers)
- Why you still need to be on the look-out for the ābond vigilantesā
- And how investors are currently positioned
This is a deep dive into whatās happening and what might happen next.
I hope youāre ready and sitting comfortably - because weāve got 50+ charts to get through.
Letās get goingā¦
āRUNNING IT HOTā
The Federal Reserve is ārunning it hotā (and this is bullish for risk assets).
They have made it clear that the recent signs of labor market weakness are enough for them to resume rate cuts.
However, inflation is rising, growth is resilient, and US stock indices are flying to new all-time highs almost every day, with forward earnings expectations being revised upwards.
This is an unusual situation, because you would generally expect to see the Fed cutting rates into a weakening economy - with inflation, growth and stocks falling.
In simple terms, ārunning it hotā means attempting to stimulate an economy that doesnāt really need stimulating.
But there are some previous instances when the Fed has ārun it hotā.
As Iāve been saying for a while in the newsletters and PRO reports - itās all very similar to late 2024.
After weakening jobs numbers during the summer of 2024, the Fed delivered 100bps of cuts, starting in September, during a time when inflation was rising and growth was resilient.
This coincided with a strong run-up in risk asset prices across the board.
And now itās ādĆ©jĆ vuā - almost exactly the same thing is happening again this year.
Weakening jobs data over the summer has led to a renewed cutting cycle being ābaked inā, starting with a September cut.
Another plausible ārecent-ishā analog is 1998, when stock markets were flying amid the dot-com boom and there was no recession in sight - but there were some small signs of a weakening labor market, so the Fed began to cut rates.
In a note, Jurrien Timmer, Director of Global Macro at Fidelity, said:
- āThe fact that the Fed is cutting rates while animal spirits are rampant brings to mind the post-LTCM easing cycle in late 1998.ā
- āThe Greenspan Fed cut rates three times even though the market was strong and there was no recession.ā
- āThe rest is history, of course.ā
- āIn fact, the stunning rebound from the 22% drawdown in October 1998 is the only analog left to match the current recovery from the 21% Tariff Tantrum in April.ā
Hereās Timmerās graphic showing āwhat happens after a 20% drawdown?ā:
If we follow this analog through from late 1998 to the peak of the dot-com boom in March 2000 - and then overlay it with today, that would translate to a market peak in October/November 2026.
Of course, the bad part about this analog is what happened afterward - the dot-com bubble bursting (-50% for the S&P 500).
On a global scale, we currently see 80% of central banks worldwide in āeasing modeā (brown line).
Source: Pictet Asset Management
This is crisis-level global central bank easing - only matched by the 2001 dot-com bust recession, the 2008 Great Financial Crisis recession, and the 2020 pandemic.
Yet, thereās been no crisisā¦
In some ways, we are seeing ārun it hotā on a global scale.
Fed rate cuts are important globally - because they allow other central banks the ability to ease more, should they want to.
So, they further fuel central bank easing globally.
I think this Fed ārunning it hotā policy is currently one of the main driving forces behind risk asset markets - and is one of the most important things to watch in the coming months.
Interest rate traders are currently pricing in roughly two more Fed rate cuts this year, and a further roughly two or three cuts in 2026.
However, there is a risk that if the Fed doesnāt deliver the two further cuts expected this year - this may cause risk asset markets to throw a tantrum.
This ārunning it hotā outlook hinges on an assumption that we wonāt see a major growth slowdown in the coming months.
But I do have quite a high conviction that we wonāt - and weāll explore that further.
Letās first take a look at what the hell is going on with US stocksā¦
MELT-UP
This ārunning it hotā policy has lit a fire under a historic rise in major US stock indices.
I think itās important to frame exactly whatās happening here.
There really is no other way to describe it - itās a melt-up.
The S&P 500 has risen more than 35% in six months since the ātariff chaosā low in April.
With essentially no ābuyable dipsā, meaning sidelined investors are forced to chase the rally.
Just brutal.
The scale of this kind of melt-up is rare - weāve only seen five other comparable instances in the past 50+ years.
Intuitively - you might think that this kind of price action would be a ābad thingā and might be unsustainable.
But, in fact, the opposite is true, historically.
Itās rare that stocks will start melting up and then just stop suddenly.
And when I say ārareā, I mean itās never happened (in 50+ years at least).
Since 1970, each of the five other instances when the S&P 500 has rallied 30%+ in five months, itās continued to move up over the next 2 to 12 months (but generally at a slower pace).
Strong price action leads to strong price action - and melt-ups last much longer than most people expect.
Weāre early in this melt-up, from a historical perspective.
And yet, my general impression is that a lot of people are still bearish (Iāll back this up with positioning and sentiment data later).
My hunch is that the ābear marketā that occurred between February and April was just so violently quick that many people didnāt really have time to adjust.
āProfessional contrarianā Jason Shapiro, a veteran trader who has made a 30+ year career out of taking contrarian views, believes this current US stock market rally is āthe most hated rallyā heās ever seen.
He said:
- āAlmost without a doubt, the most hated all-time high in the stock market Iāve ever seen in my life - which means it probably has more legs.ā
- āI canāt remember any rally thatās been hated like this at the highs.ā
- āIāve seen rallies off lows that were hated - thatās pretty typical - the move off the low in 2009 was hated for quite a while.ā
- āBut a rally this hated at all-time highs? I donāt think Iāve ever seen it.ā
One aspect of the equity melt-up that could be concerning is that overall breadth has not been great in recent months.
The S&P 500 has continued to melt-up, but the āequal-weighted S&P 500ā (RSP) has stalled out (indicating the rally is being fueled by a relatively small number of names within the S&P 500).
This is something to watch for sure - youād ideally like to see the rally ābroaden outā as it continues for a sign of a āhealthyā bull market.
This ābroadening outā would also be when you would expect to see other speculative investments catch a bid (Iām looking at you, crypto).
Additionally, rate cuts are good news for small cap equities (Russell 2000), which are more sensitive to interest rates than larger firms.
And when you see Russell 2000, just think Ethereum.
Itās basically the same chart.
Asset managers and hedge funds have actually been shorting the Russell 2000 in recent months in quite considerable size - even though it has been rising strongly.
It looks like they might have dug themselves into a big hole.
They have now started to cover their shorts - but thereās potentially a big short squeeze still to come here (bullish).
Letās now take a look at whatās going on with global liquidityā¦
LIQUIDITY
Global liquidity is rising - which is a bullish sign.
Whether you look at more detailed measures of liquidity - like the comprehensive CrossBorder Capital Global Liquidity chart.
Or simpler measures of Global M2 money supply (theyāre essentially the same chart).
Itās rising - and this is good news for risk assets.
The longer-term Global M2 money supply year-on-year cycle is also still looking constructive.
The upswing that began in late 2022 appears to be continuing - although it has been falling recently (largely due to base effects).
Below you can see it overlaid with S&P 500 year-on-year percentage change:
And here it is overlaid with bitcoin year-on-year percentage change:
All of these global liquidity/M2 measures are dollar-denominated - so where they go next is largely a function of the value of the dollar relative to other currencies.
All previous Global M2 money supply ādownlegsā (2011/2012, 2014, 2018 and 2021/2022) have been fueled by a strongly rising dollar.
So, if you can predict what the dollar will do next, you can predict what dollar-denominated global liquidity will do next.
This is not an easy task, however.
What Iām seeing at the moment is that the Dollar Index (DXY) chart looks quite ābottom-eyā on many technical levels - which is a little concerning.
It looks like it might want to move higher from a technical perspective (bullish divergences).
Iāve also written previously about the fact that positioning and sentiment on the dollar reached āextreme bearishā levels earlier this year and likely needed to be reset before a further continuation lower.
The DXY has largely moved sideways since then - and some of this excessively bearish positioning has been rinsed off.
Futures positioning has somewhat reset back to a neutral level - but Iām not confident weāve reset enough here.
Iām generally bearish on the dollar on a longer-term horizon for a number of fundamental reasons - not least, the Trump administration appears to explicitly want a weaker dollar.
But, for me - itās definitely a concern here in the shorter-term, as far as future risk asset strength goes.
The more the DXY strengthens, the more of a drag it will become for risk asset prices over time.
Hereās how I see the potential scenarios:
- A strongly rising dollar would not be good news for risk assets.
- If it just continues to chop around sideways here for a few months - this would be less concerning.
- But if it can continue to drop lower - this would be the most bullish outcome.
Elsewhere, we no longer have to worry about the rebuild of the Treasury General Account (TGA).
Iāve written a few times about how this was a temporary $500bn liquidity drain, starting in June, as cash moved from money markets into the TGA.
This process is now very close to being completed - the Treasury General Account will likely reach its target level within a couple of weeks ($850bn) - which is good news for overall liquidity.
Next, letās take a look at financial conditionsā¦
Uh, Ohā¦ š§ The rest of this report is exclusive to Macro PRO and All Access members!
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WHATāS LEFT INSIDE? š
- Gauging current financial conditions to get a clearer outlook
- Where are we in the Business Cycle?
- One key thing to watch out for
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