Being Jerome Powell is a pretty thankless job.
At this juncture, you’ve got to think ol’ Jay is questioning the relative wisdom of agreeing to take the reins from Janet Yellen.
Initially, we weren’t predisposed to being sympathetic. After all, he knew he was signing up to be Fed chair during a late-stage expansion under a president hell-bent on overheating the economy. Even if you think the Phillips curve is all but dead, that’s still a precarious position to be in.
Additionally, Powell surely realized there was something inherently dangerous about presiding over balance sheet runoff at a time when that same president was issuing mountains of debt to fund the same stimulus aimed at juicing the same economy that the Fed is bound, by mandate, to slam the brakes on if it shows signs of overheating.
Throw in the fact that there has never been a Fed tightening cycle that hasn’t ended in tears for someone, somewhere, and you come away wondering why anyone would want the job, let alone a non-economist.
Now, though, we can’t help but feel a little bit sorry for Powell. After all, he took a lot of the blame for the Q4 selloff and then, when he rescued markets in January (here and here), he was rewarded with cat calls from the peanut gallery which accused him of “folding”, “capitulating” and being a generally pathetic, embarrassing, spineless excuse for a human being. That, even as the same people throwing the tomatoes were enjoying the best January for their longs since 1987.
In any case, it’s too late to turn back. The burden of proof is now squarely on the data when it comes to putting additional rate hikes back on the table and as we noted on Sunday evening, the horse has left the barn on tweaking balance sheet runoff. It’s almost inconceivable that QT won’t end early or be adjusted after last week’s “special statement” on the normalization plan.
Given that, it’s probably time go ahead and ask what stocks usually do once the Fed is done hiking. It’s possible that the loosening of financial conditions occasioned by January’s dovish relent could free up some room to squeeze in another hike later this year, but that seems like a high bar at this point.
“The Fed’s dovish statement last week indicated that the hiking cycle begun in December 2015 may have come to an end”, Goldman wrote on Monday afternoon, adding that “the Fed’s decision to remove the hiking bias from its statement cemented the market’s pricing of no fed funds rate hike this year.”
So, what happens next? Well, Goldman has some good news on that front. There are obviously all manner of ways to approach this question (i.e., using different windows for performance), but the bank reminds you that “US equities have generally performed well after the Fed stopped hiking, with the exception of the Tech Bubble collapse in 2000.” Specifically, the bank notes that “the median S&P 500 return following the last Fed hike of the past four cycles was 7% over three months and more than 15% over 12 months.”
Whether this is useful information is questionable. Obviously, it’s nearly impossible to know, in advance, whether a hiking cycle has ended or merely been put on “pause”.
With that in mind, Goldman goes on to say that “the ends of past hiking cycles occurred when the market was still expecting further hikes [while] today, in contrast, market expectations for Fed tightening have been declining for months and now indicate no hikes in 2019 or 2020.”
Fortunately, if you look at situations where the Fed had recently hiked but the market subsequently priced out further hikes (in other words, situations like where we find ourselves currently), the S&P has historically performed well, again with the exception of the tech bubble.
Of course the circumstances investors are faced with in 2019 have no historical precedent on all manner of fronts. For one thing, Donald Trump is President of the United States and while that argues (literally) for dovishness, it also means the Fed may ultimately be forced to confront another unprecedented government shutdown and/or a technical US default if Trump decides to employ the same kind of brinksmanship with the debt ceiling that he has with the border wall battle.
Additionally, it goes without saying that Powell will be hard-pressed to offset the deleterious knock-on effects for the global economy of an all-out trade war if Trump suddenly decides he doesn’t like what he hears from Beijing.
Further, there is obviously no historical precedent for what the Fed is trying to do with balance sheet rundown and that probably renders an already small sample of ostensible historic analogs not analogous.