Do you want to trade around the June Fed meeting?
Of course you do.
After all, what’s the point of a bunch of central bankers getting together if it’s not to move markets?
You already know the setup. A hike is baked in. But long-term rates ain’t buyin’ the reflation narrative. So you know, flatter curve.
Specs did trim the eurodollar shorts through Tuesday. They also pared 10Y longs. That would seem to suggest some trepidation, but then again this is spec positioning which is usually a contrarian indicator.
As for the Fed itself, they’re grappling with on-again-off-again data (with “off again” dominating on the “hard” side). Stripped of any nuance it’s full employment versus realized inflation – “who you gonna trust?”
If inflation (and long-term yields) are right and you move too aggressively, you choke the economy. If the labor market is right and you fall behind the curve, then inflation eventually moves sharply higher, possibly putting too much upward pressure on wages and thereby squeezing margins which might have already peaked.
Meanwhile, there’s the whole reflexivity problem – who’s actually driving this clown mobile at this point? Is it markets telling the Fed what to do or is the other way around or is it both?
And on, and on.
Well, irrespective of the actual backstory, Goldman wants you to know that there’s some “FOMC alpha” available to those who are willing to study their history. Find a few excerpts from a Friday note below.
Via Goldman
Market participants and policymakers are well aware that asset prices respond to new information released on FOMC announcement days (Exhibit 1). What is perhaps less well known is that a sizable portion of average yearly asset returns is generated on these days (Exhibit 2).
For example, between 1994 and 2017, the average daily annualized return on a long position on the S&P was 6.8%, of which about 37% was earned, on average, on the eight FOMC announcement days.
As another example, a strategy that goes short the USD versus a basket of all other G10 currencies on FOMC announcement dates has provided an average daily annualized return of about 80bp, while the average daily annualized return from implementing the same strategy on any other day of the year was about 30bp.
Equities and foreign currencies have tended to generate positive excess returns on FOMC days (Exhibits 3-4). In particular, on FOMC days, the S&P 500 has historically moved up by an average of 30bp and other G10 equity markets indices have also delivered positive returns. These returns are statistically different from average returns on any other day of the year.
Turning to currencies, the USD has tended to depreciate versus all other G10 currencies, except for JPY. In EM FX space, we concentrate on the most liquid currencies and find that they have all outperformed the USD on days when the FOMC meets (Exhibit 5).
In general, across G10 and EM FX, currencies with a wider interest rate differential versus the USD have provided higher returns (Exhibit 6). This suggests that a portfolio that goes long high-yielding currencies and short the USD could potentially deliver the best relative performance on an FOMC day.
“But long-term rates ain’t buyin’ the reflation narrative”
The Fed is raising into weakness for the first time since the 1930’s. A recession is way overdue, and bubbles abound everywhere. If Janet has a clear plan (and I’m not certain she does) I suspect it’s to get rates high enough so when the recession hits, she has some headroom to cut. That is, she’ll cut rates to battle the recession she is precipitating.
I know, it’s circular logic, but it makes as much sense as anything else the Fed has done since about 2010. She pops multiple asset bubbles and Trump gets stuck holding the bag, like Shrub in late 2008.
Hence, the 10y isn’t reacting much to Fed hikes, because major bondholders know rates are just going to come down again, and soon. And depending on the depth of the recession, they’ll go to zero. Again.