Yesterday’s post, for the eagle-eyed amongst you, quoted the final line we would have got from Pulp Fiction, if it had gone in chronological order. It’s a (perhaps overly subtle and overly 1990s pop-culture related) reminder that sequencing counts. Before tonight’s Fed meeting, the market had always gone behind the Fed, which itself appeared to deliberately want to be behind the curve. In other words, so much deflationary gloom meant you had to fight the deflationary demon at the door, so the Fed were going to do “lower for longer”, and the market went even further with “lower forever”. So, rates were low and expected to remain low. And that, quite frankly, has been the story ever since 2008. It may well have been the story for longer than that, what with the Greenspan/Bernanke/Yellen Put apparently designed to chop rates if ever stock markets had a significantly nasty wobble.
But what if the sequencing has changed? What if instead of going behind the Fed, who go behind inflation, that the market goes ahead of the Fed, who also start to get ahead of inflation? Then the picture starts to look very different. Very different indeed. Yield curves start to look, dare we say it, normal. Rates in the long term are much higher than rates in the short term – usually a sign that the future of the economy looks a much brighter place. It’s also a sign that we might properly be able to exit the crazy unconventional policy of the past few years. No need to continue with negative interest rates if the economy needs and can withstand significantly more positive interest rates in the longer term.
This almost sounds like heresy. Can this be? Could we be emerging from a decade of perma-zero rates?
The fact we have to ask this question shows just how ingrained into market psychology it has become.
Blondemoney flagged up two years ago how the central banks started a competitive attempt to out-ease one another, “Hands Up if You’re Not Easing“, in the wake of the oil price collapse. Without oil disappearing to $zero there was always a chance that the drop in inflation would reverse. And so it has proven – and not just oil-related inflation either. One of BM’s faves is China PPI, which came in even higher than expectations again, at a barnstorming 3.3%:
And so the really important part of tonight’s Fed meeting is those pesky dots. Not because they might turn out to be right, but because it’s a change in our mentality. Instead of ignoring the dots because we were so convinced of the deflationary story, now we are paying attention to the increase that shows 3 hikes in 2017 AND 3 hikes in 2018. We are right to do so. The facts have changed, sir, so we are changing our minds.
So this is the message you should take away from tonight:
1. Fiscal boost aint even begun to be priced
– The market prices just over 2 hikes next year. The median Fed member sees 3. And that’s before any sign of any fiscal stimulus (the jury is out on whether this actually happens, but it’s a story everyone wants to believe in at least until Trump’s inauguration on Jan 20th). –> meaning that the market was already below a Fed which hadn’t fully taken on board the fiscal changes that the recent back-up in market yields was supposed to represent
– Some Fed members did incorporate fiscal projections into their forecast –> meaning that the market is even further away from Fed members who are taking into account the fiscal boost
2. Yellen isn’t always and everywhere an uber-dove
– All the commentary ahead of tonight’s meeting said “yeah but Yellen is always dovish in her press conference”. It was as sure a sign of complacency as any. Past performance is no guarantee of future returns.
– But isn’t Yellen scared to be bold? She did fear what happened with the taper tantrum. Who wouldn’t, given that it happened 6 months before she started as Chair, and having been handed the poisoned of chalice of trying to charter the Fed through its first rate increase in several years? But her fear doesn’t make her blind. The fear meant that she has always waited until absolute calm before delivering very well telegraphed rate moves. Usually allowing the market to get its own fear out of the system first. This time around, the bond market already suffered a move of similar magnitude to the taper tantrum – but everything remained relatively calm. No contagion. Perfect cover to unleash your inner hawk.
1+2 suggest that US curve steepening isn’t yet over, and nor therefore is dollar strength.
No, for those to turn around we need signs that the new Trump administration isn’t Reagan v.2.0, or that the US economy is finally plateauing and growth and inflation are naturally starting to slow as we hit full employment.
But those are stories for another day. For now, take whatever you did since Trump won and repeat. You just got the green light for higher yields – but also, with the final event risk of 2016 out of the way, the green light to keep on buying that equity market dip. Fill yer boots.