Yet, when I look at the traditional executioner of bull markets (the Fed), I see a reformed killer who has little interest in hurting any fledgling recovery.
[Editor’s note: The following excerpts are from a longer piece by Kevin Muir, formerly head of equity derivatives at RBC Dominion and better known for his exploits as “The Macro Tourist.” The full piece is available exclusively to his subscribers. Those interested can check out the new MacroTourist here.]
If we accept that in the past, the Fed’s tightening has marked the end of bull markets, it behooves us to figure out when that might happen this cycle.
And herein lies my reasoning for being more optimistic than most folks.
When Powell took the reins of the FOMC, he was convinced that financial excesses were the largest danger to the economy.
Yet, that attitude was quickly adjusted after seeing the damage that could occur if he maintained his hawkish stance. After nearly crashing the stock market, Powell changed tack, and tried his best to stay out of the limelight.
Yet, since then, he has also spent a full year listening to regular people. The Fed embarked on a “Fed Listens” cross-country tour where they learned how their policies were affecting everyday Americans. And what did Powell learn? Here are his own words from the opening of the Fed Listens summary document:
One clear takeaway from these events was the importance of sustaining a strong job market, particularly for people from low- and moderate-income communities. Everyone deserves the opportunity to participate fully in our society and in our economy.
Over the past year, the Fed has made a 180-degree shift as to what’s important. Gone is the obsession with inflation. Instead of focusing on that portion of the mandate, the Fed has embraced the full employment aspect.
And why not? Does it make any sense to tighten rates the moment the most disadvantaged members of society finally have a chance at getting a job? Why should the Fed target an unemployment rate? Make no mistake, by embracing the Phillips curve, that’s what the Fed was doing. The more people who got jobs, the more the Fed cranked rates.
For my hawkish brethren, before you send me your comment about why it’s important for the Fed to maintain the purchasing power of your dollars, let’s remember that what you or I believe to be the appropriate policy is irrelevant. All that matters is what the Fed believes to be appropriate. So, you might have a different interpretation of what should be done, but I have no interest in debating that aspect. What I ask is what you believe will be done.
To me, it’s clear the Fed has shifted. Whether it’s their newfound focus on employment, or their adoption of average inflation targeting, this is not the same Fed of the past quarter century.
In the coming years, they’ll let the economy run way hotter than in the past without panicking with higher rates. How hot? I don’t know the specifics and will leave that to the econometricians.
Does that mean 3% unemployment and 3% PCE? I’m not sure. Nor does it matter. All you should focus on is this: The market will assume the coming cycle will see a similar reaction function from the Fed, but will be shocked at how different things end up.
Of course, the Fed will raise rates as the economy emerges from this recession. I’m not disputing that one bit. They will do exactly the same thing they have done every other cycle. However, the rate at which they do it will be slow. Extremely slow. The market will price in rate hikes, and in the past, the Fed would have been loath not to deliver. But this cycle they’ll drag their feet.
This will surprise markets, but really, it shouldn’t. The Fed has told you exactly what they’re going to do. It’s just that no one believes them.
I remember the same thing occurring during the COVID crisis. The Fed essentially told the market they were going to buy everything with a CUSIP, yet the market didn’t believe it. It took the Fed actually writing the blue tickets before the market realized they were serious.
Same deal here. It will take unemployment running hot and inflation above target, with the Fed standing pat, before the market realizes the Fed means business. At that point, there will be a dramatic repricing as markets have become conditioned for a certain Fed response, and when they don’t get it, it will change the whole investing landscape.
This is why I’m more bullish than most other pundits. The Fed won’t stop the rally anywhere near as quickly as they have in the past.
Can we get corrections in the coming months? You betcha! I almost guarantee it.
Yet, when I look at the traditional executioner of bull markets (the Fed), I see a reformed killer who has little interest in hurting any fledgling recovery.
I know this seems crazy. We are already getting manic behavior in certain parts of the stock market. Surely, the Fed must be worried when they see EV names exploding higher, and Bitcoin’s parabolic rise must frighten them.
Yet, I don’t think they care anymore. The COVID crisis has forced the Fed to reevaluate what they believe is important.
And I’m convinced employment and economic growth will trump everything else. Inflation and frothy financial condition worries have been relegated to the back seat.
At some point in the coming months, we’ll get a correction. It’ll be quick and seemingly come out of nowhere.
You’ll hear all sorts of talk about “why the rally is done.” It’ll be scary, and you’ll be tempted to sell. The perma-bears will be trotted back out onto financial TV, and they’ll once again seem smart.
However, that’s the decline I want to buy, not sell.
Yeah, another change in the world of markets when comparing post- to pre-COVID…”employment and economic growth will trump everything else.”
Thank you for periodically sharing these notes from Mr. Muir. Greatly appreciated.
Thank you for this insight, H. Have a restful, fun, healthy holiday.
Very helpful, thanks.
Mr. Muir is very convincing.
The contrary scenario I’d think about is if the Fed sees Congress continuing to withhold fiscal stimulus, leaving the Fed and its limited tools as the only support, such that asset prices fly higher and higher while ordinary Americans sink deeper and deeper. At some point Powell might decide that the gap between Wall and Main is intolerable, and that the Fed needs to force Congress’ hand.
The other scenario I’d think about is if Congress takes away so many of the Fed’s tools that all Powell can do is suppress rates and create liquidity in money. We think of the Fed as able to buy anything and drop money from the skies, but Congress can easily clip those powers. If over-use of those limited tool results in negative real rates and forced extreme risktaking, Powell might decide that his medicine is killing the patient.
I don’t know how likely these scenarios are. I doing think the are outlandish.
Considering partisan incentives and recent behavior of Republicans in Congress I believe continuation of a divided government supports both of your scenarios. A Warnock/Ossoff victory in Georgia would undercut them.
I am worried about the future and the competition. Every nation state will be trying to get an edge in employment and production. The Chinese are so close to being the top dog they are straining at the lead. They have the pick of the best educated, the money to invest in the best equipment to produce in scale, and they are worming their way into third world countries that have raw materials they need to ensure they have enough. Any new industries and technology we develop they copy and can dominate if they want. We must control our military equipment production ourselves. No matter the cost. but there aren’t enough jobs to employ everyone in just this area. (I hate to have to give Trump any credit but the ‘Space Force’ is going to be of critical importance in the future.) A lot of our industrial might is now outdated and no longer competitive. It will take years to rebuild. Will we now be in the position of always playing catch-up??
Agreed. “Unemployment targeting” was perhaps more appropriate in the past when unemployment seemed more driven by dissatisfaction with work/wages, leading people to look for new opportunities. That in effect drove up wages while the cost of assets were more reasonable. People could get by without work for a couple months. Now, unemployment signals a lack of opportunity with an economy near full capacity, which has completely different dynamics. It does nothing for the average person, and asset valuations are now extreme. Honestly I’m not sure this is much better but I understand the Fed’s position given lack of fiscal spending. Very twisted situation. I guess it’s human nature to push things until they break, but the likely “breaking point” is far off and will be very severe this time around.
Lourdes: The short answer to your question is most certainly yes! Soon China will have a legitimate, fundable call call on more than 25% of the world’s resources and that demand will rise as they raise more and more of their people into the “middle class.” (Some estimates say 400 mil are already there — more than the population of the US.) The trillions we have wasted on stupid wars (yes, stupid) over more than two decades has given China much time to remain mostly invisible while it catches up with other top nations without anybody really believing they are doing it. As the attitudes of a huge proportion of our population have shown this year, denial is a powerful urge. People are denying the existence of COVID from their death beds. Every time I read a story about China that reports economic growth, scientific accomplishment, etc it almost always contains words such as:: “If you believe their numbers.” If there’s a bet in Vegas for over/under on numbers from China, I’ll take the over. After all, they’ve been making half our stuff for decades. If the stuff is good enough for us to buy why not buy the numbers? The rise of tech and a long history of a driven culture have allowed, even supported, China in their quest for hegemony in a way never seen before. Tech, especially, has created opportunities for China at just the right time. They are leapfrogging us with their own stuff. They now make the fastest supercomputers and now entirely out of Chinese parts. Frankly, I’m kind of glad I’m old. If you want to see where one man sees this going read Neal Stephenson’s “Snow Crash.”
I always remember Kevin saying ..’I am not here to tell you what should be just mostly what will be ‘ He was right and we all sensed
it ,, The issue I see now is that an awful lot of people see the exact scenario articulated in this post exactly as does Kevin. I being somewhat contrarian and usually preemptive agree with what he is saying as well. That is cause for worry because there starting to be a few too many people on the same side of this boat… Powell to me is being a lot more pragmatic about his actions than most of us would have imagined a couple of years ago.. He is more in agreement with his predecessors but again if you do the math and view the geopolitics the explanations for the trajectory we are on is painfully obvious , We are being forced by circumstance into a specific set of actions ( most nations) and that adds to the predictability of the outcomes we may come to see. These outcomes will not likely make us as a group feel like the geniuses that we obviously are (pun)..