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Wait, What?

If you don't have a sense of humor, the market's reaction to the Fed minutes was probably pretty frustrating for you. 

If you don’t have a sense of humor, the market’s reaction to the Fed minutes was probably pretty frustrating for you.

Initially, it looked like folks had determined that the committee wasn’t hawkish enough. Specifically, everyone seemed to be selectively keying on some of the more dovish language around the inflation outlook as equities initially spiked and the dollar took a dive. Here’s one excerpt that got some attention:

However, some participants saw an appreciable risk that inflation would continue to fall short of the Committee’s objective. These participants saw little solid evidence that the strength of economic activity and the labor market was showing through to significant wage or inflation pressures.

Of course there’s been some “solid evidence” of just that since the January meeting and indeed the entire selloff that rocked markets earlier this month was predicated on the idea that the average hourly earnings number that accompanied the jobs report “proved” (or at least “suggested”) that inflation pressures were building. That, in turn, presages a more hawkish Fed. Don’t forget the interplay here. Here’s DB’s Kocic:

What complicates things is that the behavior of real rates at this point is also a function of expected inflation: Higher inflation warrants a more hawkish Fed and therefore pricing in higher real rates. The reaction of stocks is a non-linear function of inflation – although risk assets might “like” higher inflation, this would remain true only up to a certain point.

And here’s the bank’s Dominic Konstam:

A Fed “behind the curve” maybe about a (bear) steepening in the nominal curve but if it is about a steepening in the real yield curve i.e. the promise of much higher real yields in the future, it is more ominous for equities all else being equal as opposed to a steeper inflation curve. The inflation curve matters not so much because of the threat of higher future inflation per se but because as and when the Fed no longer tolerates higher inflation at any stage, a more aggressive rise in real rates will likely reduce risk neutral rates, which is negative for equities.

That said, it could well be a stretch to assume that markets were extrapolating what the Fed thinks about inflation now (i.e. in light of recent data) versus what was a very tenuous outlook as communicated in the January minutes. So maybe Occam’s razor is better here. The Fed was pretty unequivocal on growth and a general desire to proceed apace with hikes and so, cue the following set of tweet-charts from Bloomberg’s Luke Kawa:

Now think back to this that we highlighted first thing Wednesday morning from Morgan Stanley:

1. Real yields matter most… Because earnings are (arguably) boosted by higher inflation, the rise in rates above expected inflation (real yield) feels like the most powerful driver of relative attractiveness. In one of the more remarkable developments of the last five years, US 10-year real yields have been remarkably stable in a 0-80bp range, implying little change in long-run policy expectations.

2. …and are close to breaking their five-year range: But recent moves do take us right to the top of this range. Given how supportive this range was for multiple expansion, we think the risks of a break support the argument of Michael Wilson and our US equity strategy team that multiple expansion is over,and earnings are now in the driver’s seat.


Anyway, the bottom line is that the reversal was dramatic. Here’s 10Y yields:


And here’s the long end (yields up as much as 7.8bp to 3.231%, highest since July 2015):


And have a look at the reversal in the dollar:


Of course given all of the visuals shown above, you already know what happened to gold (pump and then dump bitchez):


Meanwhile, you can imagine what happened to stocks (the initial knee-jerk rally on the dovish inflation comments from the minutes was reversed as yields surged):


By the close, stocks were lower across the board, with the Dow and the S&P logging their second straight day of losses after snapping a six-session win streak to start the holiday-shortened week on Tuesday.


You could see it comin’, goddammit (note the time stamp):

One way or another, the Fed minutes spoiled it for the bulls today and predictably, the action was characterized by an ill-advised knee-jerk that was reversed in short order.

As noted earlier, make sure you know what you’re doing before you charge out and try to trade on Fed minutes that no carbon-based lifeforms could have possibly read and digested in the time it took for stocks to surge in the immediate aftermath of the release.


6 comments on “Wait, What?

  1. To tell the truth, which I rarely do, I was shocked by the spike in the S&P while the 10 yr was in the dumps. Went out to buy some tenderloin steaks from my favorite butcher and it looks like it all worked out. Time heals all wounds.

  2. Can someone explain the following portion of the quote from Dominic Konstam in the article: “. . . a more aggressive rise in real rates will likely reduce risk neutral rates, which is negative for equities.” Aren’t low risk neutral rights part of what has been positive for the present value of equities? Thanks.

    • I beieve what is meant there specifically is lower risk-neutral growth rates. Could be wrong as I don’t recall the quote. But the way to understand this in 10 words is higher real rates = higher discount rates = lower equity valuations. Then add in the notion of capital flows from equities to bonds and you have a good starting point.

  3. “make sure you know what you’re doing before you charge out and try to trade on Fed minutes“

    Ain’t that the truth. In a purely amateur moment, I squandered 2 weeks of profits from my futures trading portfolio today. Seems like in an elevated vol environment, ride the build up, hedge, and fade the move.

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