The final Fed meeting of the year, and it’s all fully priced for a hike. December hikes: Janet Yellen is a fan. Remember last year when the first one was supposed to cause utter disaster? Remember that last Dec, they thought they would be doing 4 hikes this year? Remember this September, deep in the bowels of “lower forever”, when US 10 year yields hit a record low of 1.32% and some thought the next move might be a cut? Remember all of this, because it’s a reminder. Not a reminder of stupid central banks. Not a reminder that they’re unpredictable. Not a reminder of our own infallibility (although that’s always a good life lesson). No, it’s a reminder that it didn’t really matter. This year has all been about buying the dip. Buy bonds on any dip for yield; same for EM; same for equities. Money had to be put to work. In part this was driven by the central banks’ policies of lower for longer, that’s true: but also because of market structure and how volatility is now volatile itself. So it slams quickly into reverse: fear at its most dreadful turns out to be the point at which you want to go into max greed. We don’t go back to “normal”, we go into uber-risk loving. Volatility eats itself on the downside as well as the upside.
But let’s just look at that US 10 year yield chart… as we have just now had quite a reversal. In fact , we are starting to get closer to reversing the entire 30 year bull market in bonds. Oh but what’s that you say? There’s no good reason to expect a break out of the past 30 years?
No, there’s just the return of massive political risk premium for the first time in 30 years….
The installation of a potentially fiscally lax new US government…
And the return of inflation, with China PPI emerging from deflation after 5 years…
So as you watch the Fed tonight, there’s one chart to consider. Those pesky dots, which everyone said had become irrelevant. Yes, in part they had, because they kept getting revised down and the dispersion within the Fed kept widening. But to put it into context, with 75bps of hiking hitting the 10 year since Trump was elected, the US yield curve is still only at the 2nd most dovish dot (chart courtesy of the excellent must-follow @toby_n):
And if Janet Yellen remembers anything of last year, she will no doubt take heart from having seen the same size bond moves as the taper tantrum, but with almost 100% less contagious volatility. So why not embrace the move higher in yields?
This will be the meeting where we look back and realise it all changed. That the central bankers really were irrelevant. That monetary policy was dead. That the die was cast. That buying the dip was delightful while it lasted, but that volatility was about to ramp exponentially higher. That instead of eating itself, it would vomit itself. The periods of excessive risk seeking would be punctuated by excessive risk aversion. Bring on 2017!