Earlier today, Art Cashin summarized most (very desperate) traders' thoughts when he said that as a result of today's market crash, "the Fed will try anything" to prop up the wealth effect it had so carefully engineered with seven years of central planning in the aftermath of the financial crisis. Perhaps the only question left is "where is the put", or where on the S&P 500 is the Fed's breaking point beyond which Yellen will have no choice but to make a statement, or take action, in support of the market.
Yet one person who is far less sanguine abou the latest in a long series of central bank bailouts of the stock market is Macro-Allocation's Paul Brodsky, who believes that instead of the Fed Put, the time of the Fed Call has come.
The Fed Put Call
Investors are blaming Fed rate hikes, and hence a strong dollar, for weakening global output, commodity prices, and global equity prices so far in 2016.
The Fed knows exactly what it’s doing.
Equity returns are certainly dismal thus far in 2016. Through January 14 at 14:00PM EST, the MSCI World Index had declined by 8.6%. Accordingly, “the markets” had begun to doubt the Fed’s resolve to hike rates four times in 2016. Fed funds futures implied the December Fed Funds rate at 0.70%, up only 34 basis points from the current rate (0.36%). This implies the market is betting the Fed will hike once or twice more.
Clearly, investors see the equity markets as the leading indicator of Fed policy. We disagree. The Fed no longer works implicitly for equity investors (i.e., “the Fed Put”); it is primarily working for the U.S. banking system by stabilizing and increasing its deposit base, and for the state by providing an incentive across the world to invest in Treasury debt. By raising rates, it increases the exchange value of the U.S. dollar.
We have argued that global output growth would have to naturally decline given the extraordinary leverage already built into the global economy, leaving observers to acknowledge in 2016 that recession is near. We have argued further that the Fed is very aware of an imminent global slowdown, and that a logical strategy in such an environment would be for it to import global capital by keeping the dollar un-challenged as a store of value (see King Dollar).
We would like to reiterate and refine our view: despite increasing discomfort among equity investors, we think the Fed will remain resolute in its effort to maintain or increase the interest rate differential between U.S. and foreign sovereign rates.
The one thing that would change the Fed’s current policy would be if global growth shows signs of increasing – not decreasing.
If the world economy were to strengthen then the Fed’s incentive to keep the dollar strong would fade.
Investors should consider this meaningful shift in policy when deciding how to allocate across asset classes. As we noted in The Pain Trade last year, falling long-term Treasury yields are the last thing speculative (i.e., levered) investors expect. Following this week’s auctions, it may be time for them to cover shorts.
His conclusion: "Global equity markets are suffering so far in 2016 because the Fed’s primary policy has shifted from protecting asset prices to protecting the exchange value of the dollar. Buy USDs and Treasuries"
If he is right, watch out below, especially if hints such as this one by San Fran Fed president John Williams, who famously admitted several days ago the Fed was wrong about the "benefits" from crashing out, are an indicator of broader Fed thinking:
- WILLIAMS DOESN'T SEE SIGNS ASSET VALUES DEPRESSED, BELOW NORMAL
With the WSJ adding that "Market Volatility Unlikely to Deter Rate Rises Over Next Few Years" - hardly what the abovementioned desperate traders wanted to hear...