As discussed here on Saturday [6] and as should be abundantly clear from the sheer confusion that reigns across markets ahead of this coming week’s all important FOMC meeting where the absurd (and frankly terrifying) fact that the fate of the financial universe hinges on 25bps will be on display for all to see, the Fed is at risk of committing a policy error of epic proportions.
To reiterate, the use of the term “epic” here has nothing to do with the magnitude of the hike which, if it occurs at all, will be more symbolic than anything else, and everything to do with the fact that in today’s centrally planned world, which for seven years has been coasting along on an magic carpet made of printing press money even as the entire system becomes ever more unstable, the smallest policy error will reverberate exponentially.
To be sure, whether or not Yellen has made a mistake will become all too clear over time. All one need do is observe whether EMs careen further into chaos and/or whether the PBoC becomes even more schizophrenic, but as far as what to watch in the immediate aftermath of the FOMC announcement, we return to what we noted [7] after September’s NFP print when we quoted BofAML. To wit: “If they do hike, watch the long-end.”
Why? Because if there’s a flight to safety and the long bond rallies, the Fed will know it has officially erred, or, to quote Deutsche Bank:
The market still looks cheap for a September policy error. We see scope for Treasuries to rally significantly from here given the likely risk-off market response to a policy error – we think 10s could rally to 1.75% given the confluence of poor market liquidity and monetary tightening from the Fed and emerging market reserve loss.
In this extremely untenable situation, even doing nothing could end up producing the same result if that “nothing” is communicated poorly:
Even a hawkish hold is likely to keep downward pressure on the slope of the curve and risk asset valuations.
And as BofA suggests, the places to be in such a scenario will be "cash, volatility, and gold." At that point, any and all "pet rock" jokes will cease being funny and the only thing humorous will be the sudden disappearance of the transient bid for USTs once everyone who piled in simultaneously realizes that their own actions in the wake of liftoff definitively signal the loss of any credibility the Fed, and by extension, the fiat money regime itself, had left.
