Thursday’s overarching narrative was that this time around, Jerome Powell isn’t going to bend the proverbial knee to equities.
The emphasis on “this time” is, of course, a nod to Powell’s dovish pivot on January 4, 2019, when, while seated next to Janet Yellen and Ben Bernanke, our shell-shocked protagonist took the first steps down the road to abandoning the rigid policy stance that contributed to the worst December for US equities since the Great Depression.
Were it not for the pandemic, that U-turn would’ve defined Powell’s first term as Fed Chair. It may have been his legacy. The familiar figures (below) offer a trip down memory lane.
Powell was mercilessly lampooned for the abrupt about-face illustrated by the figure on the left (above). Some critics conveniently omitted any reference to the angry president with the rogue Twitter account who spent the better part of two years arguing publicly for negative rates, aggressive debt monetization and competitive currency devaluation. At one point, he went so far as to suggest the Fed was actively seeking to subvert America’s economy by not easing fast enough, and reportedly explored avenues for “firing” Powell.
I bring that up because those with a penchant for poking fun at the Fed always seem to “forget” that it wasn’t just stock prices “asking” for a dovish pivot in 2018 and throughout 2019. In fairness, Twitter is a relatively new invention, so it’s possible that previous presidents would’ve been equally vocal about their own policy preferences, but somehow I doubt it. The only person more adamant than Donald Trump about the benefits of a beholden central bank is Recep Tayyip Erdogan.
In any case, politics is a factor this time around too, only now, political expediency demands rate hikes, not rate cuts. That puts politics at odds with markets. At least until the US slides into a technical recession, possibly as early as the advance read on Q2 GDP. (I’m just kidding. Or not.)
In the meantime, the vaunted “Fed put” does appear to be struck much lower. Powell did manage to get that across on Wednesday afternoon. Market participants now view equities as being “in the crosshairs,” Nomura’s Charlie McElligott wrote Thursday, noting that Powell’s emphasis on the difference between this cycle and last telegraphed an extreme hawkish asymmetry. “The Fed has shifted into an outright asymmetric view on inflation, with zero tolerance for further upside surprises from here,” he added.
It wasn’t obvious (to me anyway) that Powell meant to put so much emphasis on the “this time is different” point. Everyone understands current conditions are nothing like those that prevailed when the Fed last attempted to normalize policy (figure below). Powell wasn’t telling anyone anything new when he noted that CPI wasn’t 7% in 2015 (or in 2018), nor was it news to anyone that the labor market looks quite a bit different now than it did then.
Powell, bless him, may be “nimble” in his approach to making policy, but he’s the furthest thing from it when it comes to discussing policymaking in real time. On Wednesday, he seemed to run out of ways to deflect inquisitive reporters attempting to extract specifics about the timing, pace and scope of forthcoming rate hikes. Lacking the kind of deep mental Rolodex one needs in such a scenario, he repeatedly defaulted to a talking point about the differences between 2022 and yesteryear, making it seem as though the juxtaposition had somehow just dawned on the Committee — as if January was the first time it had occurred to them that economic conditions really are anomalous right now, and thus demand an appropriately aggressive policy response.
In any event, it doesn’t matter now. Markets heard what they heard. And what they heard was an acknowledgment that the Fed put, to the extent it still exists, is struck much lower than spot equities. That opened a trapdoor in Asia, but stateside, stocks are still caught up in the “mad Greeks,” and thus aren’t to be trusted.
It’s possible that, in our zeal to guesstimate where the Fed put might be struck in 2022, we’re overlooking the fact that US equities are already down 10% and the Fed hasn’t even started tightening yet. Indeed, they’re still actively easing. A 50bps rise in 10-year reals over four weeks was good for ~11% lower on the S&P (at the lows), with Fed funds still glued to the lower bound and QE flows still in the market.
Extrapolation is always spurious, so I’ll just pose this as a question: What does that say about the odds of the Fed being able to hike five (or six) times in 2022 while simultaneously running down the balance sheet? If that’s the plan, they stick to it and growth decelerates meaningfully, stocks will — how should I put this? — de-rate “like nobody’s ever seen before,” to hijack one former president’s bombastic cadence.
“The inability of stocks to retain a bid wasn’t particularly encouraging for the Fed’s potential to deliver more than the 100bps of hikes priced in for 2022,” BMO’s Ian Lyngen and Ben Jeffery wrote, in their characteristically measured tone. “As weakness in equities extends, concerns regarding overall financial conditions could leave investors apprehensive the Fed might lack the conviction to accelerate hiking if the inflation data dictates.”
Yes, indeed. And if stocks don’t get to Powell, maybe the curve will. “The one clear theme is in UST curves, where traders seem intent on twist-flattening these things until we invert into a (premature) ‘recession’ signal,” McElligott remarked. The 2s10s flattened aggressively on Thursday, for example (figure below).
That “put[s] the low from November 2020 at 57.8bps as a next logical target,” Alyce Andres wrote. “Beyond that, some are targeting the 40-50bps area.”
It also seems possible the Fed isn’t satisfied that reals have risen enough. They’re still deeply negative out to the 10-year. If the Committee’s hawkish bent exacerbates burgeoning growth concerns, putting further pressure on breakevens, they may not have to wait long for reals to make a run at positive territory.
I’d be concerned about Friday were it not for the distinct possibility that a lackluster read on personal consumption for December serves as an “offset” of sorts to what’s almost guaranteed to be another hot ECI print. PCE prices will come in scorching too, so it’ll be incumbent on University of Michigan sentiment to douse the flames with more dour commentary about the extent to which the consumer is discouraged by higher prices. Of course, if the Fed isn’t going to be deterred anyway, then the combination soaring labor costs, above-target inflation and a discouraged consumer could be the worst possible combination. It may not even matter depending on what Apple reports.
McElligott on Thursday wrote that Powell “effectively ‘co-signed’ recent financial conditions tightening.” “I’d say that any substantial rallies from these levels in equities gives the Fed further ‘hawkish clearance’ to bomb-out high strike calls,” he added.
Let’s see how brave Powell is if (or when) the curve inverts on him.