This Is The ‘Trickiest’ Thing For Today’s Macro Traders

You’d be forgiven for thinking that the chances of another Fed hike this year are about as good as the chances of Donald Trump deleting his Twitter account.

After all, the incoming data between now and December is going to be rendered at best noisy and at worst meaningless by Harvey and Irma (the hurricanes, not the Florida couple who quit their jobs stocking shelves at Wal-Mart to day trade VIX ETPs).

On top of that, the timing in December will coincide with more political wrangling and an environment characterized by extreme fiscal uncertainty isn’t exactly conducive to a rate hike that isn’t fully priced by markets. Oh, and if they do start normalizing the balance sheet, and it roils markets, that could change their calculus on rates.

It probably doesn’t help that August payrolls were a disaster either.

The uncertainty surrounding the future leadership of the Fed complicates things further – at least in investors’ minds.

As Bloomberg’s Cameron Crise notes, this is “a particularly acute issue for currency and bond traders,” but given the fact that the fate of the risk rally depends in no small part on whether policymakers exhibit an “appropriate” level of dovishness as they attempt to normalize, one could well argue that it’s even more “acute” for equity investors, especially considering the fact that the retail variety isn’t usually very informed and is thus subject to being unhedged and blindsided.

With that as the setup, read Crise’s latest below on the importance of separating what you think policymakers should do from policymakers actually will do…

Via Bloomberg

One of the trickiest things in macro trading is to distinguish between what you think policymakers SHOULD do and what they WILL do. It is all too easy to conflate the two and project one’s own beliefs on how the world should look onto the most likely actual policy outcome. This is a particularly acute issue for currency and bond traders with respect to monetary and fiscal authorities — especially in an era of unorthodox policy regimes. Anyone who assumes policy action –or inaction — on the basis of their worldview risks a painful comeuppance from the market.

• “What should the Fed do with monetary policy?” This is an interesting intellectual question, and one that is an appropriate subject of debate for both academic economists and pundits. For investors, however, the real question is what the Fed WILL do — and the answer to the two aren’t always the same
• Lately, the market’s conclusion is that the Fed will do almost nothing through the end of next year — there is less than one full tightening priced by December 2018. This is a function of several factors:
  • Hurricanes Harvey and Irma are going to significantly distort the economic data for the next few months, and the assumption is that they will shut up shop (other than this month’s balance sheet policy shift) until clarity emerges
  • Inflation is below target, and a growing body of the FOMC are concerned about this issue. With Stanley Fischer’s departure, the Phillips curve adherents lose a champion and the “Brainard wing” of doves may gain ascendancy
  • In any event, the large number of vacancies on the board, and the forthcoming vacancy of the chair, makes it difficult to project anything — so the default is to project nothing
  • Both politics and geopolitics are less favorable than they appeared at the start of the year
• The historical precedent suggests that the Fed will look through the hurricane impact to a potential tailwind from rebuilding. NY Fed president Dudley suggested as much on Thursday. Is this time different? Perhaps, if the doves get their way
• We know that the committee will tilt a bit more dovish with Fischer’s departure, at least this year. But the composition next year — at least among known personnel — should become more hawkish thanks to the rotation of the regional Fed presidencies
• Ultimately, the direction that the Fed opts to take will depend on both the personnel and the data. There are a lot of unknowns on both fronts, so right now it seems like the Fed SHOULD do nothing. Just remember, though, that the unknowns will eventually resolve themselves — at which point there is certainly a chance that the Fed WILL do something
• If it all seems quite difficult, take comfort in the fact that the market has historically had a hard time pricing the Fed cycle accurately — and often underestimates the extent of a policy shift as it occurs