Noise Machine

I’m just as exhausted with Fed speculation as the next guy. More so, in all likelihood. After all, I’m compelled to obsess over such things pretty much around the clock.

Only a small part of that obsession is attributable to open positions. My recent foray into DeFi notwithstanding, I’m notoriously conservative with my asset allocation. The obsession is thus mostly voluntary. Strictly speaking, I don’t have to spend each evening scanning every Bloomberg news alert from the past 10 hours in search of something I might’ve missed.

But if you’ve ever known someone prone to obsessive-compulsive behavior, you know “voluntary” only applies if there’s something of overriding importance going on. If the house were on fire, I wouldn’t succumb to the imagined necessity of word-searching a Bloomberg feed for “Lagarde” on an ECB Thursday and reading every, single headline and digesting every crumb of incremental color. But absent some intervention (for lack of a better word), my mind won’t let me rest until it’s satisfied I’ve fed it all available information.

Despite the mental drain, I do like the “background noise,” as Lloyd Blankfein put it recently, during a surprisingly illuminating interview with a characteristically obsequious Erik Schatzker. I’m uncomfortable without that noise.

I say all of that in a (hopefully successful) effort to animate and otherwise breathe life into yet another attempt on the part of the sell-side to speculate about what the best historical parallel might be for the forthcoming Fed tightening cycle. These are repetitive, but so are headlines and news snippets. And my mind takes the same view on analyst color as it does on news feeds: I have to read them. If I don’t, I’m anxious.

There’s a silver lining to that somewhat torturous mental prison. As noted, I like the “noise,” but it also arms me with a limitless supply of factoids and data points, without which I’d be bereft on some days. Whatever the topic du jour happens to be, I can pull from the mental encyclopedia. It’s the same reason I try to read at least one book every month, and stay up to date on New Yorker articles. I’m no genius. I just read a lot.

Among today’s fabulous factoids: The S&P 500 has averaged a 16% total return (8.1% annualized) during hiking cycles dating all the way back to 1954, higher than the 12% average annual return in all years. That’s according to the latest installment of BofA’s “RIC Report.” It’s illustrated in the figure on the left (below).

On the right (above), the bank plotted the 2004-2006 hiking cycle against their economists’ projections for this cycle. That’s the best analogy, BofA reckons.

Before you tune out, note that this is extremely relevant, and not just because the trajectory of policy rates is the topic du jour. Recall that Jerome Powell’s efforts (in the January press conference) to emphasize the differences between this cycle and 2016-2018 were an aggravating factor for equities during last month’s rout. Although stocks certainly don’t want a repeat of 2018 (in that sense, everyone hopes this cycle is different), Powell’s point was to highlight that current conditions are indicative of a very tight labor market and a hot economy. That was hawkish, and risk assets responded accordingly.

In the same cited note, BofA wrote that “the backdrop for the last hiking cycle bears few similarities to where we are today.” It’s preferable, they wrote, to look at 2004-2006, when,

The Fed did 17 consecutive 25bps hikes, faced with strong growth and hints of inflation. [Our] expected path of rate hikes tracks the ’04- ’06 cycle well. This cycle demonstrated that an economy with strong fundamentals can withstand hikes and that gradual, predictable hikes can be digested by markets.

Needless to say, the Fed isn’t going to hike 17 times. So, if the fundamentals really are “strong,” then equities should be even more resilient this time, provided the Fed is, in fact, predictable in its approach.

On Wednesday, Raphael Bostic (who inadvertently subjected market participants to an amusingly awkward good cop/bad cop act late last month), adopted a measured cadence in an interview with CNBC. Currently, he has three hikes penciled in for 2022, but he’s leaning “a little towards four.” At this point, he’s “thinking very much” in 25bps increments, but didn’t rule out 50. “Every option is on the table,” he said. The market shouldn’t think the Committee is “locked into a particular trajectory in terms of how rates have to move over time.”

For her part, Loretta Mester told a virtual event that although she doesn’t like “taking anything off the table,” she also doesn’t “think there’s any compelling case to start with 50bps.”

“We’ve got to be a little bit careful,” Mester mused, during the same remarks. “Even though you can telegraph what’s coming, when you take that first action, there’s going to be a reaction.”

Duly noted.