While the market's jarring response to Ben Bernanke's (very much un)surprising Taper pre-announcement has been extensively documented and discussed, and is most comparable to the tantrum unleashed during the summer of 2011 debt ceiling negotiation when the market's ultimatum that US spending must go on or the wealth effect gets it, the key question at the heart of the market's confusion is whether Bernanke has telegraphed the start of tightening or merely the end of easing. Stock bulls, obviously, defend the latter while those who dream for a return to normal, uncentrally-planned markets are hoping for the former. But what do the facts say?
The charts below show the 10 previous Fed cycles with the dates of the last rate cut vs. first rate hike. The average time distance between the last rate cut and the first rate hike has been around 15 months.
As per JPM's compilation, the behavior of the 5 asset prices a year before and after the last Fed policy rate cut is shown below. Yields declined in the year before and rose in the year after the last rate cut. It is worth emphasizing that the moves in yields are not adjusted for carry and that most of the 60bp of the average yield increase after the last Fed policy rate cut would have been offset by carry. The UST curve steepened in the year before and was little changed in the year after the last rate cut. Credit spreads exhibited negative correlation with yields, widening in the period before and tightening in the period after. Equities were in a bull market, rising before and after the last rate cut. The dollar was little changed overall.
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The behavior of the 5 asset prices a year before and after the first Fed policy rate hike is shown in the next chart below. Yields started rising 3 months before the first Fed policy rate hike. The cumulative increase in the 10y UST had been around 80bp, starting 3 months before the first hike up until 6 months after the first hike. Again a large chunk of this yield increase would have been offset by carry. The US Treasury market experienced bear flattening post the first rate hike. Credit spreads and the S&P500 had been rising consistently before and after the first rate hike. In contrast, the dollar had been weakening.
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JPM's take?
Which period is the most comparable to the current one? Strictly speaking, the QE stock approach suggests that it is the one-year period before the last Fed policy rate cut that is more comparable to the current period, assuming the Fed ceases bond purchases in June 2014. The Fed’s forward guidance complicates the comparison though, as a case can be made that a change in rate guidance is now the same as an outright rate change. This makes it more likely that the market reaction is shifted earlier and will be more similar to the period after the last Fed policy rate cut.
Strategically, JPM sees a perfect goldilocks in either case: rising stocks (good luck with that), slowly rising rates, and improving credit.
By looking at market moves post the zero mark... this would imply a benign environment of modestly higher UST yields, rising equities and tighter credit spreads.
In other words, precisely the opposite of what the market has indicated so far!
Of course, the reason why this time really is different when it comes to the dislocation of the Fed from the market, is that never before has the Fed been so inextricably involved from both through stock (20% of US GDP held hostage by the Fed) and flow (injecting 0.5%+ of GDP into the stock market in the form of low-powered money each month). Add to this the sheer market terror that the flow impact from the BOJ may and likely will fade very soon, and of course the ongoing unwillingness of the PBOC to join its reckless 'developed markets' central bank peers, and it becomes quite clear why both charts above are completely meaningless.
However, the will provide macro tourists countless hours of deeply uninsighful watercooler conversations over the next 7 days, and shallow pundits hours of regurgitation why even a tightening by the Fed is bullish for stocks (was Tepper busy buying shovels to bury the shorts in the past few days?) and why grandma would be an idiot not to BTFD.