Whether he meant to or not doesn't matter, but shortly after Chair Powell opened his mouth yesterday at 2:30pm for the last Fed press conference of 2018, all hell broke loose once the former Carlyle partner announced that not only will the Fed likely hike 2 more times in 2019, but the shrinkage of its balance sheet is on "auto pilot", sparking fears that the Fed is leaving stocks on their own for the first time in a decade as it pursues Quantitative Tightening, and leading to a 1.5% drop in the S&P500, its biggest plunge during an Fed announcement day in recent history.
And as Nomura's Charlie McElligott writes this morning, Fed’s QT double-down and 'tone deaf' dots has reinvigorated a “policy error” “end-of-cycle” growth-scare market response.
According to the Nomura strategist, "tactical traders are looking to “rent this” for a quick long in SPX as “peak hawkishness,” but will then sell it into expected “dovish walk-back” from Fed-speakers come January. In the meantime, the USD selling and front-end of Rates curve inversions (and also the re-appearance of a SIZE buyer in the long-end not just in US but also EGBs) are communicating the obvious deterioration of US growth expectations and the growing “self-fulfilling” risk of recession increasing."
Those who have been following McElligott's rising bearishness will be familiar with his structural stock view: "play for tactical bear-market rallies as expected in Jan, but in the larger sense, QT will continue a “sell rips” risk-asset mentality as reduced USD liquidity and tighter financial conditions drive weaker inflation expectations and wider credit spreads as negative macro drivers of Equities, as my “tightening ourselves into a slowdown” tantrum materializes."
The good news - for bulls - is that since the Fed believes it is raising rates only to cut later, the seeds of the next easing cycle have already been planted. As McElligott points out, the only curve to have inverted before each of the past five Fed easing cycles is the ED2-6, and this curve inverted late last week.
What does this mean? On average, looking at these past five easing cycles, the first Fed rate cut has occurred 143 business days after the ED2-6 curve inverted—which applied in this case would in theory see the Fed Easing as early as mid-Summer ‘19.
That's the good news.
The bad news is that if the Fed is being led by the economy - which remains far stronger relatively speaking than the market and in many ways immune to the troubles around the world - the summer of 2019 may be a time when the Fed is still hiking, and since Powell doesn't appear especially concerned by the drop in stocks - as Tepper David confirmed this morning when he said the Powell put is dead - what happens next could be ugly.
Very ugly in fact, because as McElligott concludes, there is one final analog worth noting, and it’s not a good look at all — using "max selloff since Sep 20th to present" and screened back to 1929, McElligott "ominously" sees the highest correlation to the current environment in the 2007/2008 selloff period, to wit:
The current cumulative SPX return from Sep 20th ‘til now looks shockingly like the SPX 1Y return profile from Oct 9th 2007 through Oct 3rd 2008—yikes.
Incidentally, if this dire analog is accurate, the S&P should halt its decline somewhere around 1,500.