Wednesday's Market Minute: Trading a "Trampoline" Landing

Last week I wrote about how the Federal Reserve might repeat the “transitory” mistake by letting fears of so-called “lagged effects” of their hiking program distract them from sufficiently combating inflation in the near term.

We found out Tuesday that indeed it looks like lagged effects are giving way to something more like economic renewal. Data smashed expectations across the board, from durable goods to housing and confidence. This adds onto weeks of steady improvement in the economy, not just relative to analysts’ expectations, but also as measured by credit spreads and financial conditions. 

The catastrophic meltdown some were looking for after the banking scare this spring just doesn’t look to be in the cards. Soft landing now appears higher probability than hard landing, and “no landing,” a description some prefer, also seems reasonable. Let me offer a fourth, the Trampoline Landing, in which the economy quickly bounces back. This would be defined by a reversal in PMIs and/or jobless claims. It may be the lowest of probabilities, but it’s where investors’ attention should be focused, because it’s where the risks now lie. 

It’s a less daunting threat than hard landing, but the trampoline bounce has the possibility of stoking demand in a manner sufficient enough to reignite inflation, and that would break a lot of widely-held assumptions. 

The most obvious one is in the stock market, where the indexes are now trading positively correlated to yields. It’s a U-turn from a year ago, and means investors do not fear inflation right now, largely because of the dovish stance to which the Fed has positioned itself. Traders expect two 25-basis point hikes, and seem fine with that. If the trampoline landing is real, watch for the terminal Fed funds rate to start pricing even higher.

For traders, the trampoline landing should mean broader, more cyclical rotation in the stock market, at least until the Fed is forced to get more aggressive. It should also mean higher long yields, but maybe not a higher dollar or more deeply inverted yield curve until the Fed raises the terminal expectation. Wild cards could include a rebound in commodities like crude and copper.

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