‘End Of An Era’: Sea Change Seen In Abruptly Hawkish Fed

Risk sentiment took a hit Thursday, as global equities responded to a Fed which, by appearances anyway, abandoned any pretense to “patience” during December’s deliberations.

It’s probably apt to describe the minutes of 2021’s final policy meeting as “overtly” hawkish. On Wednesday, I said they merely “skewed” in that direction. I try to adopt a measured cadence when possible, but there was no mistaking the sense of urgency. I still wouldn’t call it panic. But, as one headline put it, the Fed “left gradualism behind.”

This tightening cycle, truncated though it may ultimately be, will not proceed at a snail’s pace. Notwithstanding various nods from participants to the utility in adopting a “measured” approach, most officials were (and, one assumes, still are) ready to get on with it.

The runoff discussion underscored as much. “After pussyfooting around the start of tapering for months, the Fed theme changed rapidly to faster tapering, and earlier and more rate hikes,” Rabobank’s Philip Marey wrote. “Now we can add earlier and faster balance sheet reduction.”

Read more: Verbose And Ill-Organized

Markets priced an 80% chance of liftoff in March, and a second hike in July. More than three full hikes were priced by the end of 2022, which effectively put the market and the Fed on the same page. Remember: There’s still a co-authored script. Nomura expects four hikes this year, which could push US 10-year yields towards 2%.

Benchmark yields jumped to multi-month highs across the globe. 10-year JGB yields were the highest since April, bund yields the highest since May of 2019, and yields in the UK, Australia and New Zealand rose markedly too.

TD recommended a long in the US two-year just prior to the release of the minutes on Wednesday. “While we expect the Fed to hike in June, September and December this year, we believe that a hike as early as March would be very aggressive especially given the recent rise in COVID cases,” the bank’s Priya Misra said.

“The spike in infections should have a modest negative impact on the economy, and signs of slowing Q1 growth could be enough for the market to push out the start of the hiking cycle,” she added, suggesting hesitation “should help pull two-year yields lower in the near-term.” In other words, Misra is fading the elevated market pricing for March liftoff shown in figure (above).

The read-through for equities is clear enough: Anything synonymous with the vaunted “duration infatuation” is likely to feel the heat assuming Fed officials don’t start talking equities back off the ledge in the days ahead. Profitless tech and other quasi-leveraged long duration bets could come under extreme pressure.

“The minutes confirm what many expect — there is a broad consensus at the Fed that policy normalization should proceed as fast as is practical,” SocGen’s Kit Juckes wrote Thursday. “Overall, faster tapering, earlier rate hikes and earlier balance sheet reduction are all on the cards if the economy and asset markets allow,” he added, noting that “the bigger longer-term question is whether there is enough stickiness to the inflation rate to force the FOMC to tolerate a deeper equity market correction than they might have in recent years before changing tack.”

In other words: Where is the Powell put struck these days? If inflation continues to be viewed by The White House as a larger political liability than a prospective stock market swoon, the answer is probably “lower than it was in 2018.”

Just 56% of Americans report owning any stock at all. The middle class’s share of corporate equities is in danger of falling into the single-digits. Everyone, by contrast, needs to eat and pay for shelter. And the midterms are coming up.

That suggests the Fed will prioritize the inflation fight over rescuing elevated tech multiples — “apolitical” though they may be.

“We have to admit, [a March hike] would seem radical for a Powell Fed,” JonesTrading’s Mike O’Rourke remarked, suggesting officials might try to convince the market to push back liftoff timing by at least one meeting.

“Nonetheless, if the FOMC were to quickly flip from QE to interest rate increases and balance sheet contraction, the equity market should have a much more violent reaction,” O’Rourke went on to write. “This is the end of an era — for years, markets have placed exorbitant multiples on growth stocks because ‘there was no alternative,'” he said. “Seemingly overnight it’s beginning to appear as if there will be ample alternatives by year end.”

Ray Dalio told investors cash was “stupid” on Tuesday. He said the same thing in January of 2018, a year defined by the same policy bent the Fed looks poised to adopt in 2022. By the end of that year, cash was the best-performing (traditional) asset class on the planet.