Market Comment - July

The past month was characterized by investors being underweight equities and having to chase the stock market, which continued to trade up in a straight line. On Wall Street, this is called “climbing the wall of worries.” Geopolitics and tariffs are the main reasons investors remain skeptical towards the current rally, but neither was able to stop the financial fireworks.

The ongoing earnings season had a positive impact, as expectations from analysts were not high, and beating expectations was not hard. More importantly, the AI trade is in full force, and those who have been trading and investing for more than 25 years reminisced about the internet bubble of the year 2000. While some market participants believe that the Nasdaq is trading in a bubble, we doubt that is the case now. Market bubbles are a result of too much liquidity provided by central banks in response to a problem that turned out to be not so problematic after all.

In 1998, financial markets witnessed the collapse of the LTCM hedge fund, coupled with the Russian default on its domestic debt and the devaluation of the ruble. The Asian financial crisis, which started in 1997, acted as background noise. As a result, global central banks poured liquidity into the financial system, and the Fed cut interest rates during the last quarter of 1998, from 5.50% to 4.50%. In hindsight, it was an overreaction, but it provided the fuel for the bubble that started in 1999.

A minor bubble was created by central banks during Covid, where again an exogenous event sparked a liquidity stampede. As we have mentioned several times here, we are living in a fragile financial system, built on debt and leverage. Central bankers are aware of this. As a general rule, it is better to be safe than sorry. To build a bubble, we need more liquidity. The ECB is already in a very dovish position, having cut rates eight times already. The Chinese central bank is slowly but steadily loosening its monetary policy, which we expect to continue this year. For the bubble, we need the Fed to step in.

In recent weeks, the U.S. President has been insulting the Chairman of the Fed, Jerome Powell, relentlessly, urging him to cut rates, because the U.S. economy is the best ever—which is, unfortunately, a bad argument. A great economy does not need lower rates. But in the U.S., a President attacking the Fed chair is nothing new. Those inclined to view President Trump’s needling of Federal Reserve Chairman Jerome Powell as an unprecedented breach of decorum might wish to brush up on their monetary history.

The truth is, tormenting the Fed chairman—whether through verbal assault or political manipulation—has long been part of the American political tradition. Both William McChesney Martin (1951–1970) and Arthur Burns (1970–1978), despite their reputations and resolve, eventually bowed to pressure from their respective Commanders-in-Chief. In both 1966 and 1971, monetary policy took a conspicuous turn toward accommodation—not because the economic data demanded it, but because the men in the Oval Office did.

At the beginning of August, Adriana Kugler submitted her resignation as a member of the Board of Governors. This opens the door for Donald Trump to appoint a new member of the Board of Governors, who in the end could also become the next Fed Chairman. Maybe only a small hiccup is enough to get the U.S. central bank cutting, even if it is not needed, and the inflation target is not achieved.

Bubble please? Let’s do this!