I’m back with another Milk Road Macro PRO report - and it’s a big one.
This is where we take a very wide bird’s-eye view of the most important factors driving markets.
It’s basically been “risk-on” since April - and animal spirits are alive and well.
I’ll show you why things are still looking good for more upside - there’s no need to panic.
However, there are a number of important things to watch carefully for potential shifts in markets.
We’ll look at:
- Why the Fed’s “run it hot” policy is important
- The historic stock market melt-up (and why it’s the “most hated rally ever”)
- 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 “bond vigilantes”
- And how investors are currently positioned
This is a deep dive into what’s happening and what might happen next.
I hope you’re ready and sitting comfortably - because we’ve got 50+ charts to get through.
Let’s get going…
“RUNNING IT HOT”
The Federal Reserve is “running it hot” (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, “running it hot” means attempting to stimulate an economy that doesn’t really need stimulating.
But there are some previous instances when the Fed has “run it hot”.
As I’ve been saying for a while in the newsletters and PRO reports - it’s 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 it’s “déjà vu” - almost exactly the same thing is happening again this year.
Weakening jobs data over the summer has led to a renewed cutting cycle being “baked in”, starting with a September cut.
Another plausible “recent-ish” 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:
- “The fact that the Fed is cutting rates while animal spirits are rampant brings to mind the post-LTCM easing cycle in late 1998.”
- “The Greenspan Fed cut rates three times even though the market was strong and there was no recession.”
- “The rest is history, of course.”
- “In 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.”
Here’s Timmer’s graphic showing “what happens after a 20% drawdown?”:
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 “easing mode” (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, there’s been no crisis…
In some ways, we are seeing “run it hot” 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 “running it hot” 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 doesn’t deliver the two further cuts expected this year - this may cause risk asset markets to throw a tantrum.
This “running it hot” outlook hinges on an assumption that we won’t see a major growth slowdown in the coming months.
But I do have quite a high conviction that we won’t - and we’ll explore that further.
Let’s first take a look at what the hell is going on with US stocks…
MELT-UP
This “running it hot” policy has lit a fire under a historic rise in major US stock indices.
I think it’s important to frame exactly what’s happening here.
There really is no other way to describe it - it’s a melt-up.
The S&P 500 has risen more than 35% in six months since the “tariff chaos” low in April.
With essentially no “buyable dips”, meaning sidelined investors are forced to chase the rally.
Just brutal.
The scale of this kind of melt-up is rare - we’ve only seen five other comparable instances in the past 50+ years.
Intuitively - you might think that this kind of price action would be a “bad thing” and might be unsustainable.
But, in fact, the opposite is true, historically.
It’s rare that stocks will start melting up and then just stop suddenly.
And when I say “rare”, I mean it’s 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, it’s 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.
We’re early in this melt-up, from a historical perspective.
And yet, my general impression is that a lot of people are still bearish (I’ll back this up with positioning and sentiment data later).
My hunch is that the “bear market” that occurred between February and April was just so violently quick that many people didn’t really have time to adjust.
“Professional contrarian” 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 “the most hated rally” he’s ever seen.
He said:
- “Almost without a doubt, the most hated all-time high in the stock market I’ve ever seen in my life - which means it probably has more legs.”
- “I can’t remember any rally that’s been hated like this at the highs.”
- “I’ve seen rallies off lows that were hated - that’s pretty typical - the move off the low in 2009 was hated for quite a while.”
- “But a rally this hated at all-time highs? I don’t think I’ve ever seen it.”
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 “equal-weighted S&P 500” (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 - you’d ideally like to see the rally “broaden out” as it continues for a sign of a “healthy” bull market.
This “broadening out” would also be when you would expect to see other speculative investments catch a bid (I’m 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.
It’s 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 there’s potentially a big short squeeze still to come here (bullish).
Let’s now take a look at what’s going on with global liquidity…
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 (they’re essentially the same chart).
It’s 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 “downlegs” (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 I’m seeing at the moment is that the Dollar Index (DXY) chart looks quite “bottom-ey” on many technical levels - which is a little concerning.
It looks like it might want to move higher from a technical perspective (bullish divergences).
I’ve also written previously about the fact that positioning and sentiment on the dollar reached “extreme bearish” 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 I’m not confident we’ve reset enough here.
I’m 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 - it’s 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.
Here’s 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).
I’ve 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, let’s take a look at financial conditions…
Uh, Oh… 😧 The rest of this report is exclusive to Macro PRO and All Access members!
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WHAT’S LEFT INSIDE? 👀
- 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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