You have to think three steps ahead these days. At least.
By now, the Fed’s acutely aware of the risks associated with telegraphing a potential step-down in the pace of rate hikes following this week’s 75bps move.
That kind of messaging, particularly on the heels of underwhelming hikes from the RBA and Bank of Canada in October, could be interpreted as a “soft pivot” by markets, leading to lower US real yields, dollar weakness and an extension of a two-week equity rally, all contrary to the Fed’s efforts to tighten financial conditions.
With consumers still spending, and the labor market still resilient, the last thing a Fed confronted with generationally high inflation needs is easier financial conditions. If there was any doubt about policymakers’ concerns in that regard, they were answered over the weekend by Nick Timiraos, ironic considering it was Timiraos who added fuel to the “soft pivot” fire when, on October 21, he suggested officials are considering a slower pace of hikes starting in December.
Thinking one or two steps ahead entails suggesting that markets are set up to be disappointed in the event Jerome Powell hews too closely to the data dependent script, forcing markets to reprice December (with higher odds for another 75bps increment) or price a higher terminal rate on the notion that a step-down actually opens the door to more tightening in smaller increments (e.g., reducing the pace cuts the left-tail risk of a deep recession, and thereby gives the Fed more runway to hike in 25bps increments from February). Presumably, those outcomes would be bearish for stocks.
But think three steps ahead by recalling recent dynamics. Everyone’s a day trader. You monetize selloffs immediately, then pile into upside hoping for a same-day rally as downside monetization and upside grabs become a self-fulfilling prophecy via weaponized gamma and the forced enlistment of dealers. This is no longer the sole purview of retail investors. The “big boys” are at it too.
“The ‘right’ outcome this week would be Powell hammering [home] a hawkish message to reverse the recent ‘impulse easing’ in FCI, stocks trade lower and bonds sell off again, as there’s no basis for ‘pivot’ or ‘step-down’ relief until the data softens meaningfully,” Nomura’s Charlie McElligott said Monday, reiterating that “a re-acceleration in wealth creation and animal spirits… would be extremely counterproductive.”
But, he went on to ask, “What if the Fed is hawkish [and] on-message [but] equities keep squeezing higher regardless?” “We’ve seen big upside reversals on seemingly ‘hawkish’ / ‘bad news’ days of late,” he remarked. The most extreme example of that dynamic came on CPI day earlier this month, when the S&P staged a 194-point reversal (figure below).
Remember: In the current environment, anyone who doesn’t cover shorts or net-up exposure into hawkish escalations risks being forced to do the same later, only into a market that’s higher. And “later” could mean a few hours, or even a few minutes.
Funds are overweight cash and underexposed. That, Charlie reiterated, creates a “buyers are higher” risk from the fundamental/discretionary crowd, where underperformance is remarkable (figures below).
The Long-Short universe’s weekly rolling returns versus the S&P suggest performance drag of more than 3.5%, an anomalously poor result that’s consistent with rock-bottom beta to suddenly/recently buoyant stocks.
On the systematic side, vol control’s allocation is very low historically, and assuming a reasonably well-behaved distribution of daily outcomes, there’s a latent buy impulse lurking. CTAs are likewise light on exposure. The proximity of buy triggers varies by benchmark.
The overarching point is that you shouldn’t assume an overtly hawkish message from Powell, or even outright pushback against the “step-down” narrative, will automatically mean a sustained selloff in equities. If recent fireworks are any indication, a knee-jerk lower could turn on a dime, with any reversal feeding on itself and leaving the unfortunate souls tasked with penning market wraps for mainstream financial media outlets even more bereft than they’d be anyway.
We are not flirting with disaster. Putin’s economy is. But not the US economy.
I like the idea of switching to a Bernanke-style messaging approach in this circumstance. What has been done so far is not insignificant. But only time will tell the whole story, whether we like it or not. Is it merited to raise three-quarters of a point? Maybe. Maybe not. We do not really know.
One-half of one percent is not nothing. The speed at which the state of the economy unfolds and how it does so are yet to be seen. Half a point at this meeting, and more half-points as needed at future meetings until they can read the tea leaves more accurately and drop to a quarter point increment makes sense to me.
interesting thought exercise when everybody / thing is a day trader – where’s money being made, people are machines? What signal / trade latency frameworks are making money – instantaneous (machines) or differing latency durations (humans). Intuition says the machines are making more money, … is that even knowable beyond each trading desk?
To make spending cash, individuals need to earn more than beer money on each trade as the volume is much lower that pro-traders/machines. The latter earn bps many thousands of times on the same pile of cash which magnifies returns quickly. I have to believe the billions earned quarterly by JPM, GS and others of their ilk reflect the inherent profitability of rapid trading regimes. In the last year JPM, for example, had trading assets of 506 bil, on which it earned 17.66 bil, for a return of just under 3.5%. I guess bps don’t add up all that fast. Of course, the markets were down double digits while they were earning this moolah so making a respectable profit on trading can’t be all that bad. 17 bil will buy a lot of beer (or single malt).
Much appreciated H. Thanks for hammering this into my thick skull.
In my opinion, the fed should raise 75bp (as everyone expects) and say little, other than in the future their raises will be data dependent. Anything else will cause a ramp up or drop down. Maybe the markets will trade sideways for a while.
I agree – less is more. The key indicators of monetary success (inflation and employment) still don’t show any real progress towards attaining their goals. To moderate the message now is to defeat all that they have put in place. Someone just recently pointed out that any even minimal signs of moderation would yield an immediate 10% bounce in the market. I think that’s right. How does that help things for the Fed?