Market corrections are painful, particularly if you have a Bloomberg on your desk and cable news running in the background. However, this is not the way the Fed views corrections.
That’s from BofAML’s Ethan Harris, and it probably doesn’t do much to inspire confidence among those of you hoping that Jerome Powell will “come to his senses”.
Ironically, there’s an argument to be made that during the Yellen years, the Fed did indeed view corrections from the perspective of a trader staring at a Bloomberg. In fact, if you conceptualize pre-Powell monetary policy as a jointly-produced, collaborative effort between the Fed and markets (with the former only moving with the consent of the latter), then the line between policy and markets becomes hopelessly blurry. The inputs become indistinguishable from the calculus into which they are fed and, by extension, from policy itself.
Recalling the halcyon Yellen days, Harris goes on to remind you that “the Fed has already paused several times in this tightening cycle [and] two equity market corrections played a big role in the delays.” These are the corrections he’s referring to:
Obviously, both of those corrections were related to China, with the first coming on the heels of the August 2015 yuan devaluation and the second accompanying a global growth/deflation scare that unfolded a scant five months later.
Should investors be comforted in the notion that Powell will ultimately relent? Probably not, BofAML reckons. The bank’s analysis is straightforward and while I’m obviously predisposed to favoring profundity, a little brevity never hurt anybody.
“The economy and the Fed were in a very different place in 2015-16”, Harris writes, before listing “the three key differences”. “In 2015-16 the Fed was much less confident about how the markets would handle hikes, less confident about the economy and less confident in achieving their inflation target”, he says.
He elaborates on those points, but the gist of it is that Yellen feared a taper tantrum repeat, did not enjoy the same fiscal backstop as Powell and ambiguity around NAIRU made it more difficult to say, definitively, that inflation would rise sustainably to target.
As is the case across desks, BofAML doesn’t think October’s correction is indicative of a looming recession. Rather, the bank thinks “this is a case of a bad market looking for an explanation.” Here’s a short excerpt:
The correction in the equity market has put a small dent in wealth accumulation in the last few years. A typical rule of thumb is that consumers tend to respond to wealth gains over the prior three years—the Wilshire 5000 is up about 25% over that period. Consumer borrowing rates have risen but are still low, leaving the ratio of debt service to income near record lows. Business confidence remains very high, particularly among small businesses. Growth overseas has slowed, but is still above its long run trend. The dollar is slightly strong, but not enough to have much impact on exports. In other words, the economic recovery is old, but healthy.
That’s likely to be small comfort to hedge funds, though. This week, Goldman said the Long/Short crowd (a $900 billion+ universe) was down nearly 9% through October 23. Considering the representation of Tech/Growth in those portfolios, it’s probably safe to say Wednesday was a disaster for those funds.
So, when it comes to corrections being “painful, particularly if you have a Bloomberg on your desk” (as BofAML’s Harris puts it), you can be sure this month has been extra “painful” for hedge funds, as is abundantly clear from the following chart:
The bottom line, for BofAML anyway, is that “this time around the markets will have to find a floor without Fed help.”
A far as the “Trump put” is concerned, that concept used to be couched in terms of the administration pausing the trade war once tensions between Washington and Beijing escalated enough to dent U.S. equity prices.
Now, Trump appears to think he can have his cake and eat it too, by insisting that the Fed activate the Powell put in part because persistent rate hikes are undermining the effectiveness (by supporting the dollar) of the very trade war that he (Trump) refuses to de-escalate.