The One Chart Showing How The Fed Lost The Battle

The Fed is this close to failure. At least that was Steve Liesman's assessment of yesterday's dour Fed statement who, as a reminder, said the following after the Fed presser:

I think the first rate hike cycle is over. What Janet Yellen said in response to my question, and if you look at what has happened to the rate hike cycle, is pretty profound. It's as close to the Fed getting to capitulation as I've ever seen, about the efficacy of Fed policy, about the outlook for the economy.

Shortly after, Jeff Gundlach validated Liesman's gloomy take: "the 'rate hike cycle' has left the building," he said after Wednesday's decision by Fed policymakers to leave rates unchanged. "They are not preparing the markets for a rate hike at all. Yellen sounds like she doesn't have confidence anymore. She is backing away from any forecast. She is simply saying, 'I really don’t want to forecast anymore.' We are done with this forecasting game. The subtext is that 'we've been so wrong forecasting the data, we should stop'."

So what really changed, and how did the narrative break so sharply after 7 years, despite this website, for one, warning every single day since March 2009 that Fed failure is the only possible outcome?

Here is BofA's credit strategist Michael Contopoulos with one succinct explanation:

Chair Yellen made one thing clear today: there is unlimited uncertainty in the Fed’s forecast for the economy, inflation, and path of growth. Since 2012 the long-term median dot projection has plummeted from 4.25% to 3% with 50bp of reduction so far this year.

And here is the chart showing how slowly but surely, the Fed lost the confidence battle as potential long-term growth has been cut by 30% in just over three years, even as the Fed was desperately doing everything in its power to achieve the precisely opposite outcome.

What does this chart mean?

In our view, it is no good to talk about rate hike projections in 2018 or beyond when there seems to be just as good a likelihood of secular stagnation or recession by then. Alternatively, if the goal is to increase inflation expectations, explicitly say that the FOMC will opportunistically reflate -as our economists expect is their real policy. The current rhetoric, in our opinion, is frankly too candid, showing little to no conviction and thereby creating little confidence in just the metrics the Fed wants to nudge higher.


Though we don’t expect a recession in 2016 (that is neither our economists’ nor the High Yield strategy house view), we do think that the underappreciated risk is that the consumer begins to rein in spending as job security becomes more of an issue later this year. Additionally, we have already seen that the steady increase in negative yielding assets has done little to affect high yield over the last 6 weeks. And should oil fall and fear replace a search for yield mentality, we think outflows, ETF selling and profit taking is likely to ensue.

Finally, here is the return of proclamations of Fed "policy failure", only this time the Fed may not get another chance:

As it relates to the Fed, in our opinion there is only downside. Hike and the market’s reaction to the substantial divergence of global central bank policy likely causes yields to go lower, uncertainty to increase and spreads to widen. Stay on hold and the reasons for not hiking (global uncertainty, low inflation, poor economic growth and weak corporate fundamentals) ultimately leaves risk assets vulnerable to shocks. In either environment we continue to recommend barbelling portfolios: high quality duration, preferably IG paper, fallen angels and new issues with lower quality issuers that have “already realized” their event.

The same barbelling which as JPM's head quant, Marko Kolanovic, said earlier this week is prudent once central banks finally lose all control: "we continue to recommend a risk barbell portfolio in which an investor holds both reflationary assets (EM equities, commodities, Value assets) and hedging assets for the possibility that central banks lose their grip on asset price action."

Judging by the price of gold, it is clear which part of the barbell investors are rushing into.

Your move Janet... if there is one.