A 'melt up' time out (except gold)

Making sense of the forces driving global markets

By Jamie McGeever, Reuters Open Interest Markets Columnist 

A burst of profit-taking and economic jitters knocked U.S. and world stocks off their record high perches on Tuesday as investors digested the ongoing political gridlock in the US and France, while gold futures reached the landmark $4,000 an ounce level. 

More on that below. In my column today I look at the asymmetric risks in the Fed's easy policy stance. Chair Jerome Powell says rate cuts are needed to support the creaking labor market, but that may be questionable. What's less debatable is the whoosh they are giving to already booming asset prices. 

I'd love to hear from you, so please reach out to me with comments at jamie.mcgeever@thomsonreuters.com. You can also follow me at @ReutersJamie and @reutersjamie.bsky.social. 

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* U.S. bank reserves below $3 trillion

U.S. bank reserves held at the Fed are below $3 trillion for the first time since January - down nearly $300 billion since late August - a clear sign that excess liquidity is being drained from the system. 

There's nothing magical about the $3 trillion figure, and it is probably well above the unknowable level where officials reckon reserves are still "ample". But it brings into focus Fed QT and the question of how low can reserves go without sparking liquidity concerns. Fed Governor Christopher Waller has said $2.7 trillion might hypothetically be an ideal level. It's not far away. 

* Bond blues

Sovereign debt markets around the world are under heavy pressure, particularly the long end of the curve, where yields have recently shot up to historic highs in many countries. And in the case of Japan, record highs. 

There was some respite for U.S. Treasuries on Tuesday, but the backdrop remains challenging. Policymakers are running economies hot with monetary and fiscal easing, just as financial markets are booming and inflation is above target. Right now, investors are more inclined to sell any rip than buy any dip.    

* Nothing's gonna touch you in these golden years

Gold futures reached $4,000 an ounce on Tuesday, and the spot market price got to within $10 of that landmark level. Bullion has climbed 20% in just six weeks, and is up more than 50% this year.

The rally must run out of steam soon, right? Perhaps. But as talk of 'debasement' trades continues to percolate, and central banks continue buying, it's not clear what that catalyst is or when it appears. 

The Federal Reserve says its interest rate cuts are aimed at softening the impact of a looming labor market rupture. Unfortunately, cheaper money is unlikely to achieve that goal, but what it almost certainly will do is fuel the "everything" rally in financial assets.

The reasoning posited by Chair Jerome Powell and the bevy of doves on the Federal Open Market Committee for pre-emptive easing is sound enough. Job growth is evaporating, which risks triggering a spiral of surging unemployment, lower consumption, and slower growth or even recession.

The problem is the Fed's go-to tool in its armory - the federal funds policy rate - is a blunt one. This has always been true, but the risks in using it now are particularly asymmetric and increasingly skewed towards unwanted outcomes. 

This is partly down to the imbalances that have taken root across corporate, economic and financial America. Consumption is driven by the richest households, who own most of a booming Wall Street, where profits, investment and market cap are dominated by a handful or two of mega companies. 

The Fed is easing monetary policy with U.S. financial conditions the loosest in over three years, credit spreads the tightest since 1998, inflation a percentage point above target, and GDP growth running at an annualized rate of around 3% or higher. 

In financial markets, the "everything" rally is in full flow - Wall Street's big three indices, the Russell 2000 small cap index, the tech sector, semiconductor stocks, gold, and bitcoin are all at record highs. 

Powell did say late last month that equity prices were "fairly highly valued", perhaps echoing former Fed Chair Alan Greenspan's 1996 speech highlighting "irrational exuberance" in markets at that time. It's worth remembering, however, that the S&P 500 subsequently doubled and the Nasdaq quadrupled in value before peaking in March 2000. 

There's no suggestion a similar boom - or bust - is on the cards. But because the wealth effect seems so prevalent, perhaps the Fed should be factoring financial market conditions into their decision-making more than they have in the past.

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