Via Scotiabank's Guy Haselmann,
Through the overly-complex verbiage riddled with a copious number of contingencies, a simple message was actually able to surface. The net result is modestly hawkish and one consistent with our "Sooner but Slower" rate cycle perspective [10].
Use of the word “patient” is analogous to “slower”; while Yellen’s comment about how it is “unlikely to begin normalization process for at least the next couple of meetings”, corresponds to a “sooner” lift-off. The marketplace had expected the first hike to occur in the June-September corridor, but Yellen moved it slightly forward to the April-June range.
The word “patient” will likely be used throughout 2015, for fear of unsettling the apple cart of bubble-like financial markets generated after six years of uber-accommodative policies. In other words, to prevent roiling Treasuries or risk assets too much -- after interfering for several years with the market’s normal price discovery functions – the Fed will have to tread carefully and slowly.
A modestly “sooner” hike is one reason why the front end of the Treasury curve is under pressure. However, a hike in ‘mid-2015’ is still quite far off and not a certainty given the worryingly and quickly changing geo-political landscapes. Therefore, due to carry and ‘roll –down’ benefits, Treasuries will not be able to price too many hikes in too soon.
The real hawkish part of the press conference was when Yellen defined the decline in oil as a “tax cut” to the consumer. The downward pressure it will have on headline CPI over the next few months, she explained as a “transitory” condition.
It is counter-factual to know whether economic progress has been the result of a normal business cycle or the result of Fed policy. After all, is ZIRP (or QE) creating jobs or impacting inflation? The plunge in the velocity of money is a sign that the Fed’s printing was not used as intended. It is a sign of extreme indebtedness. In this sense, Fed policies have borrowed from the future, while encouraging wild market speculation.
If economic progress has been more about the business cycle and it begins to turn by ‘mid-2015’ (or should a geo-political event damage rosy economic forecasts), then the Fed could lose its window of opportunity for ‘lift-off’. Is it possible that the Fed hikes even in the face of worse economic and financial market conditions? If conditions got really bad, it is possible that the Fed may not be able to hike at all in 2015.
- This is certainly the risk of not hiking even “sooner” under the nearly ideal current conditions.
Such a ‘lower for longer’ potential scenario would then be bad, not good, for risk assets.
Under such a scenario, risk asset valuations would look even further deviated from their economic fundamentals. The fallout in financial markets would likely be severe. The Fed would have to take the blame for focusing too much on its inflation mandate (of which it has little control) and not enough on the current risks to financial stability.
Too often times in history, the Fed has been the source of ‘boom to bust’ cycles. It is easy to envision that another one currently unfolding at this very moment.
Markets are being driven more by fear of missing the upside, and fear of under-performing peers and benchmarks, than by any other factor. This Pavlovian response has worked well in recent years and encouraged by the Fed. However, this pattern is in the 9th inning. Moreover, such herd-like behavior will run into great difficult due to dreadful market liquidity that is the result of regulatory over-reach; indications that were evident in markets over the past few weeks.
I asked a trader today what he gleaned from the Fed meeting yesterday. He said, “Nothing. Fed policy was completely unchanged”. If this is true, then the market over-responded. While I believe the FOMC was slightly hawkish as noted above, the global situation is too fluid to price a Fed that when they finally move will only move gradually. In the meantime, markets need to contend with problems being created by falling oil, Greece, China, Russia and other areas. Could the Ruble go to 100? Putin said he will not bother with it, so why not? How will a devalued Yen and Ruble begin to impact China?
It is all about positions into year end. Rising uncertainties and changing risk/reward distributions for portfolios will keep volatility high. Treasuries 10 years and longer will stay low for a while longer. The post FOMC re-pricings are opportunities to buy the dip in long-dated Treasuries, and pare exposures to risk assets. Fade the over-reactive moves.
“I know you think you understand what you thought I said but I’m not sure you realize that what you heard is not what I meant” – Alan Greenspan
