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One week ago, when we discussed why the Fed now finds itself trapped by the slowing economy on one hand, and the market's response to the Fed's reaction to the slowing economy (namely the market's subsequent sharp rebound, only the third time since 1938 that we've seen a V-shape recovery of this magnitude when the market dropped down more than ~10% and spiked +10% in the subsequent period), we said that the "obvious problem" is that the Fed is cutting because the economy is indeed entering a recession, even as market have already rebounded by over 10% from the recent "bear market" low factoring in a the economic response to an easier Fed, effectively cutting the drop in half expecting the Fed to react precisely to this drop, while ignoring the potential underlying economic reality (the one confirmed by the bizarrely low neutral rate, suggesting that the US economy is far weaker than most expect).
Ultimately, what this all boils down to as Bank of America explained yesterday, is whether the economy is entering a recession, or - somewhat reflexively - whether the suddenly dovish Fed, trapped by the market, has started a chain of events that inevitably ends with a recession. The historical record is ambivalent: as Bloomberg notes, similar to 1998 and 1987, the S&P fell into a bear market last month (from which it immediately rebounded) following a Fed rate hike. The difference is that in the previous two periods, the Fed cut rates in response to market crises - the collapse of Long-Term Capital Management in 1998 and the Black Monday stock crash in 1987 - without the economy slipping into a recession. In comparison, the meltdown in December occurred without a similar market event.
Meltdown - Lot
And yet, a meltdown did occur, and it has a lot to do...
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