Goldman’s Warning: “The ‘Yellen Call’ Is Back In The Money”

Now look, you can’t tell Donald Trump a goddamn thing. Everybody knows that, right?

But while we’ve all come to accept the fact that when he gets something in his head, there’s no changing his mind, you’d think he would at least listen when someone tries to say something like “hey look, it’s no so much that this is a bad idea, it’s just that for a whole laundry list of reasons, it’s probably not going to work out exactly like you think it will.”

That is, he’s not ever going to heed advice from people who tell him that this or that part of his agenda is batsh*t crazy. But I held out some measure of hope that if someone sort of half-assed agreed with him, that maybe that would be concession enough for him to then listen to the “buts.”

“But”, no such luck.

Fiscal stimulus is perhaps the best example of what I’m talking about. See it’s not like a trillion dollar fiscal stimulus program is a bad idea, it’s just that when the economy is already near capacity, dumping $1 trillion in stimulus on top of it isn’t going to translate into appreciably more growth. But what it will do is risk stoking inflation. And there’s your recipe for the dreaded stagflationary nightmare.

Trump apparently isn’t likely to heed that warning which means he’s even less likely to appreciate a still more nuanced corollary: namely that with stocks at record highs and the new administration trying to jawbone the dollar lower, the Fed is backed into a corner. Financial conditions are now so loose that they couldn’t defer a hike even if they wanted to. It also suggests that the pace of hikes may be quicker than those who are massively long risk believe.

So that’s the setup for the following commentary out Tuesday from Goldman whose analysts note that the “Yellen call” was already going to be pushed into the money by Trump’s stimulus plans and the accompanying rise in inflation expectations. But now that financial conditions are as loose as they are (especially when juxtaposed with the conditions that prevailed during the first two months of 2016), that very same Yellen call might be set to go deep into the money. Here’s more.

Via Goldman

Consistent with our Top Ten Themes for 2017, we continue to emphasise that the most obvious implications of fiscal stimulus at full employment are higher inflation and faster rate hikes.

Our caution with respect to growth exposures is rising with valuations. As Fed speak over the past few weeks makes clear, the ‘Trump rally’ has aggressively pushed the ‘Yellen call’ back into the money, as we feared.

While we have long cautioned that the ‘Yellen Call’ could become a drag on risky asset returns, our Top Ten Market Themes For 2017 pointed out that Trump’s proposed fiscal policies would force the FOMC to respond even more aggressively to further easing of financial conditions. Even if the proposed fiscal policies never materialise, the mere prospect of stimulus has already caused a material rally in the animal spirits of households, small businesses and retail investors.

As strong as the case for the ‘Yellen call’ appeared late last year, it seems even stronger now. In December, as shown in Exhibit 1, we forecast our US economists’ Financial Conditions Index (FCI) to show that if the current conditions persisted, the Fed would be faced with a meaningful easing in financial conditions come March. But current financial conditions eased even more than we expected. Financial conditions are giving the Fed the green light to pick up the pace; the ‘Yellen Call’ is back in the money