It's The Fed, Stupid

While the mainstream media were quick to blame the recent demise of US equity markets on Trump's trade-war rhetoric, BofAML's Michael Hartnett disagrees, correctly pointing out that risk assets have been struggling because of Fed tightening.

Higher rates and a shrinking balance sheet has shifted investors' appetites from 'buy the dip' to 'sell the rip'...

Via BofAML,

It’s the Fed, stupid

We believe the simple reason that risk assets are struggling in 2018 is the Fed. Investors have been forced to acknowledge a tightening cycle is well underway.

Since Oct last year the Fed has been reducing the size of its balance sheet; by the end of this year the Fed will have hiked 8 (maybe 9) times. History shows that once the Fed starts to tighten financial conditions it requires a major “event” to reverse course (Chart 1).

The tightening cycle, which the ECB & BoJ are set to join in coming quarters, follows 9 years of unprecedented global monetary easing & asset price returns. Table 1 below shows the biggest winners & losers as global interest rates have been cut 712 times and $12.2bn of assets have been purchased by central banks since 2009.

The QE winners have been US stocks, tech stocks, US & European high yield bonds, Emerging Markets(themes of scarce growth, high yield & leverage).

The QE losers have been cash, commodities, government bonds and volatility (themes of inflation, low yield & liquidity).

But, as BofAML's Hartnett warns, that is all about to change as the market is forced to admit the regime shift from Quantitative Easing to Quantitative Tightening.

  • We believe investors will slowly rotate from QE winners to QE losers, but the pace will be contingent on how quickly profit growth slows; YTD returns indicate that the rotation has begun

  • Peak positioning, peak profits, peak policy stimulus imply peak asset returns, and a trading mantra of sell-the-rip not buy-the-dip

  • If Q1 was about volatility, Q2 will be about rotation within a big, fat trading range,  rotation specifically from levered cyclical plays to liquid defensive plays

  • It’s too early to advocate a“Full Bull Detox” and overweight bonds/cash (where yields continue to be meager) and sell equities (the “TINA”argument); but a surge in US dollar/credit spreads could cause fresh lows; key deleveraging levels... GT30 <3%, DXY >93, CNY >6.5, US HY CDS >4%, SPX <2500, SOX <1200, DAX <12,000

Hartnett sees good, and bad, news under each of his Positioning, Policy, and Profits factors driving Q2 investment themes.


Good news: BofAML Bull & Bear Indicator has retreated from the dangerous “excess bullish” levels of late-Jan to a neutral levelof 5.4.

Bad news: investors have only partially unwound their crowded Goldilocks positions...short vol/Treasuries/US$, long tech/banks/EAFE/EM.


Good news: policy tightening has not led to a significant widening of credit spreads, i.e. corporate bonds not signaling a decisive crack in equities(Chart 3).

Bad news: yield curve implies monetary & fiscal stimulus maxed out; only policycards left to play are growth-negative protectionism & populism.


Good news: global EPS estimates are very strong.

Bad news: global PMIs, the key driver of EPS, are rolling over; EPS rarely this strong for this long when yield curve this flat (Chart 4); longer it takes for 10-year Treasury yield to breach 3% in Q2, the more aggressive the rotation from cyclicals to defensives and bond sensitives in Q2 is likely to be.

So either the bond market is entirely wrong or expectations for forward EPS will have to tumble dramatically.


DemandSider NemesisteM Mon, 04/09/2018 - 15:20 Permalink

The Fed/banks need the over valued dollar. As long as Wall Street's Department of Offense controls OPEC, the dollar's safe. Even without the pruning of uncooperative OPEC leaders, there are other ways to goose the dollar, through attracting criminal capital to it, encouraging tax evasion in dollars, and dollarizing desperate countries like Venezuela. The PRC, Germany; boomers' investments; the neoliberal elite, all wealthy parasites like the status quo, so it's going to stay this way for decades.

Look what has happened to former manufacturing centers in fly over land. Do they care? No. The parasites only need our aquifer (ag; hogs, etc) exports, they don't need our value added production. They've exported our democratically funded technology to their CCP owned manufacturing platform because democracy is too expensive for them. The U.S. will keep descending to third world living standards for most people, and nothing will be done. They must exploit and encourage race, religion, and gender diversity to keep the potential added sector, i.e., the working class, from uniting.

In reply to by NemesisteM

undercover brother gmak Mon, 04/09/2018 - 16:49 Permalink

They let performing assets run off, then remove the cash from their system just like they created it, which is akin to a tightening.  However, the tricky part is when the asset no longer performs, such as all the toxic MBS and other crap they bought when they were bailing everyone out.   What does the fed do?  Do they seize all the houses, banks, businesses and liquidate?  No chance.  Somewhere in there is some very creative accounting that is never audited.

In reply to by gmak

devo Mon, 04/09/2018 - 15:16 Permalink

Now you've found the disease. Stop railing on all the symptoms. Translation: The Fed was begun by wealthy, white, WASPS. Not jews and blacks, you fucking degenerates.

DemandSider devo Mon, 04/09/2018 - 16:10 Permalink

"What is the worldly religion of the Jew? Huckstering. What is his worldly God? Money.…. Money is the jealous god of Israel, in face of which no other god may exist. Money degrades all the gods of man – and turns them into commodities…. The bill of exchange is the real god of the Jew. His god is only an illusory bill of exchange…. The chimerical nationality of the Jew is the nationality of the merchant, of the man of money in general."


Karl Marx, 1844


Europe's wealthy did not help by excluding Jews from power and land ownership, and forcing them into finance, but you have to admit there are really a lot of Jews in The FIRE sector, although there are really a lot in medicine and science, too. Strategically, it's asinine to write off an entire racial, religious or ethnic group as antithetical to your own particular beliefs, because it's seldom so. Antisemitism is not only barbaric, it's politically suicidal. But, to say there aren't an inordinate number of Jews in finance and media, and politics, while were at it, really strains credulity.

In reply to by devo

abgary1 Mon, 04/09/2018 - 15:22 Permalink

And the Fed still does not want to admit they created the bubbles in the first place and are still watching the PCE (core) wondering where the inflation is.

End the Fed and neo-classical economic theory.

Read Debunking Economics: The Naked Emperor Dethroned by Steve Keen to understand how illogical neo-classical economic theory, the basis for the Fed's decisions, really is.

mosfet Mon, 04/09/2018 - 15:22 Permalink

Funny how perma-bulls have proclaimed 'Don't fight the Fed' when they were buying the dip but now that the Fed is supposedly selling, those same fools are still buying the dip.

Hint: You can't be both the dumb money and the smart money simultanously. One's selling to the other, and that other mistakenly believes it's the smart money.

Wild Bill Steamcock Mon, 04/09/2018 - 15:23 Permalink

I wish we could turn back the clock to 2008 and let the whole fucking thing collapse into the abyss.  It's like a wooden ship with a rotted-through hull.  It's taken on too much water, so patching the holes and kicking the can down the road won't prevent it from sinking.  Jump off now while the shore is still in reach and let the fucker sink.  Save the energy, effort and resources for building a new ship.