By Friday afternoons, I’m usually somewhat delirious after spending the better part of five days writing breathlessly about the intersection of geopolitics and markets.
Time was, documenting that nexus wasn’t a particularly challenging endeavor on an average week. But that changed in 2015. The geopolitical scene became immeasurably more fraught and before long, trying to keep track of whether and to what extent assets of all stripes were being influenced by politics on a given day became a Herculean task.
Fast forward to 2018 and the situation is even more complex. At least in 2015/2016/2017 you could count on predictable central bank forward guidance and asset purchases to keep volatility anchored, but now the policy put is fading, and that means the scope for geopolitical flareups to catalyze episodic bouts of cross-asset volatility is greater.
Anyway, the point is, by lunchtime on Fridays I can no longer distinguish between rants and cogent analysis, so I wasn’t entirely sure whether the following (written Friday afternoon around 2) was just me rambling or whether it actually made sense:
The Fed’s newfound data-dependence under Powell means there has to be a compelling economic rationale for pausing the hiking cycle/leaning dovish. Given the effects of late-cycle fiscal stimulus, there is no such rationale, especially not when the person in charge is tacitly insisting that there’s no room for ambiguity when interpreting the incoming data (under Powell, the data just “is what it is”, so to speak).
In light of that, the only way for a stock market drawdown to prompt a Fed pause is for the drawdown to become deep enough to materially tighten financial conditions; or said differently, for the equity correction to effectively represent a rate hike in terms of the tightening impulse and the read-through of that tightening for the economy.
That’s just a rehashing of a narrative I’ve been pushing all week, and it revolves around the restriking of the “Fed put” and the idea that we won’t see a dovish relent from Powell until stocks fall enough to exert a material tightening in U.S. financial conditions.
Well as luck would have it, a brief note penned by Deutsche Bank’s incomparable Aleksandar Kocic starting making the rounds on Friday afternoon just after I wrote the passages excerpted above and it seems largely consistent with my own narrative which presumably means my late-week ramblings were in fact some semblance of coherent.
“In our view recent market turbulence reflects continued repricing of the Fed put”, Kocic writes, adding that “when seen through the prism of financial conditions, a 15% decline in the S&P is equivalent to a 25bp rates hike.”
It seems to me that Kocic doesn’t believe the October selloff represents something systemic. You’ve probably heard a number of commentators this week suggesting that price action and the inability of beaten down sectors to stage a bounce bodes ill, but Kocic says that if you look at things through the lens of vol. markets, “the non-systemic nature of October’s developments” is relatively clear.
Specifically, he notes that if you look at the recent history of three benchmark vols (1M vol. in USDBRL for EM, VIX for equities and 3M10Y for rates), they do not move concurrently. “When rates or equities vol spikes, EM is calm and vice versa”, Kocic notes.
That marks a rather stark contrast to the longer history of the three. Prior to 2017, vol. spikes were synchronous. After 2017, asynchronous.
The upshot from Kocic’s short Friday note is that when looked at through the vol. lens, what we’re seeing in October isn’t systemic. More colloquially, this ain’t the big one (Elizabeth). Or at least that’s the way I read it.
Repricing of the Fed put (and any U.S. equity-driven tightening that comes along with it) need not necessarily be catastrophic, and I guess one thing I would add in that regard is that while this month certainly didn’t help the cause of beaten down ex-U.S. markets, Chinese equities were already in trouble before October, as were European banks, European autos, Hong Kong shares, etc. etc.
All of that said, if the dollar continues to push higher (BBDXY hit a 17-month high on Friday, before ultimately retreating), that’s obviously EM negative as are any downgrades to the global growth outlook.