Bloomberg’s Cam Crise (aka MacroMan) offering out today’s PSA to all young guns on Wall Street. I’ll say he’s always a good read BUT I have lot of respect for those under 40 as they make their way through markets. They’ve got far more tools than we did and can backtest better than I ever could imagine. Wikipedia. ZeroHedge. All other sorts of sophisticated (ie TERMINAL) tools at their disposal and YET … we like to think it’s different this time because … there are some who are involved and are young. These young guns have something on academics … life experience of trading / investing / selling as opposed to some up in the ivory tower who simply work and live in THEORY (vs the rest of us living the dream in PRACTICE).
That diatribe in mind, Cam is one who’s lived the dream and TRADED so without further pontification of mine, here’s his view to consider as the FOMC mins have changed the arithmetic a touch (June when hawkish was DOVISH to now hawkish being BEARISH)
If You’re Under 40, You’ve Never Seen a Hawkish Fed: Macro Man
Here’s a question for you: When was the last time that the Federal Reserve exhibited a “strong commitment to address elevated inflation pressures?” For years, the FOMC has been aggressive in pursuing monetary accommodation but cautious while engaged in hiking rates. If you want to know why the minutes to December’s meeting seem so important, it’s because the circumspection exhibited in the tightening cycles of the past couple of decades seemed to give way to the sentiments quoted above. The reality is likely to be a little more nuanced, of course, and when push comes to shove the Fed’s bite might not quite live up to its bark. Then again, what if it does? Perhaps bull market investors will learn that “don’t fight the Fed” might work both ways.
One of the reasons that this column has fixated on inflation so much over the last year is the implication that it has for monetary policy. During periods of broadly quiescent price pressures, central banks can engage in a relatively leisurely or measured pace of tightening -- in other words, they hike rates because they “want” to. Inflation, on the other hand, can force central banks to act more aggressively than might otherwise be the case, making them tighten because they “have” to. Naturally, the latter case implies less sensitivity to immediate financial market reactions than the former.
Anyone who started trading after the peak of the dot-com bubble will be unfamiliar with this scenario. Starting in 2001, every easing cycle has featured a rate move of at least 50 bps in one shot, while each tightening cycle has been conducted in 25 bp, forward-guided increments. Moreover, the magnitude of each easing cycle in this century has exceeded that of the subsequent tightening. This is true whether we look at the nominal policy rate or QE-adjusted shadow rates.
It’s little wonder that asset prices have become elevated in a setting where the carrot is so much larger than the stick. It seems as if the riskier the proposition, the more it has benefited from the generous monetary backdrop. Mind you, policy shifts alone cannot explain investor behavior-- after all, the dot-com bubble percolated even as the Fed was tightening rates in 1999-2000. Yet the denouement of that cycle was a 50 bp hike in May 2000; while the Nasdaq did trade higher during the ensuing few months, ultimately it took nearly 14 years for that index to trade sustainably above the levels prevailing when the Fed delivered its monetary coup de grace.
That’s a lesson that starting points matter when assessing the impact of monetary policy upon asset valuations. Probably the most important asset- market development of the year thus far has been the real rate shock that has seen 10-year TIPS yields climb 30 basis points since last Friday. A move of this magnitude isn’t unprecedented, but it is certainly unusual; since the inception of the TIPS market in 1997, there have only been 18 prior occasions when 10- year real yields have risen by at least 5 bps on three consecutive days. On only four of those occasions has the streak extended to four days: once each in 2007, 2008, 2009, and 2020.
Here’s the thing: Despite the sharp move higher in real yields, they are still lower than virtually every observation between the inception of TIPS and the start of the pandemic. There was a brief period in late 2012 when they traded below -0.80%, but for the most part they have been substantially higher than the current readings.
That rather raises the question of just how far they can go, especially if the Fed really has changed its 21st century tune.
Of course, it is easy to talk a big game in a meeting where your big policy shifts are to move a dot and to reduce the pace of asset buying. Delivering on hawkish rhetoric with actual tightening is another proposition altogether, and it is worth noting that even the hawks seemed to advocate a “measured” approach to tightening in the minutes. That language hearkens back to the 2004-06 cycle, when the Fed put rates up 25 bps per meeting like clockwork. Tightening it was, but shocking it wasn’t.
At the very least, however, the apparent timetable on balance sheet rolldown looks a lot more aggressive than that following the previous QE taper. And small wonder -- we’re a lot closer to full employment, if indeed we aren’t there already (another hawkish aside from the minutes.)
It remains to be seen, of course, just how much Fed asset holdings decline before so- called QT actually does represent a tightening. It’s worth noting, though, that “excess liquidity” levels -- reserves plus balances in the reverse repo facility -- are some $3 trillion higher today than they were when the Fed started its balance sheet reduction in 2017. It should therefore take some time for QT to “bite.”
Still, that might be of little comfort to those owning assets that trade way above a reasonable approximation of “value.” Just because something has gone from eye-bleeding territory to nose- bleeding doesn’t mean it’s “cheap” -- just look at that TIPS yield chart above. My favorite heuristic for this category of assets, ARKK, once again closed below its estimated since- inception average purchase price; indeed, owners are now in the biggest hole (in aggregate) since the height of the pandemic.
The difference, of course, is that back in March 2020, every risky asset was in a hole. As such, the negative alpha of super- speculative assets is a lot bigger this time around ... and thus seems much more likely to prompt a negative feedback loop. It’s not a coincidence that the chart of ARKK, meme stocks, and crypto all look broadly similar.
Much as it still startles me, I am now 50 years old and the only brutally hawkish Fed cycle that I’ve seen in my career came in my early 20s. The dot-com cycle wasn’t as vicious, but it endured until it popped the air out of the equity bubble. If you’re under 40 years old, you have no professional memory of these episodes, if you’ve got any memory of them at all. The fact is that the younger you are, the more you think that risky assets only go up.
That’s not what happens when the Fed is actually, properly hawkish. In fairness, it’s been more than two decades since that’s been the case. This week’s Fed minutes are no guarantee that the Fed really is going to change the habit of many investors’ professional lifetimes ... but they do offer a window of possibility. That’s something that everyone should think about when considering when and where to buy the dip
This is a perfect addition TO what was visualized by THESE CHARTS OF THE DAY — noted HERE earlier — including this fan fav — which itself exudes the very RECENCY BIAS discussed above
AND since we’re all getting more educated on the Fed hawk-O-dove'meter, I must admit to having killed another tree. I’ve printed this and it sits on my desk with my monthly indicator forecast calendar. Here is an FOMC 101 as per WFC
Stronger-than-expected inflation has taken markets by surprise, setting the stage for major policy shifts in the coming year. The FOMC will hold its first monetary policy meeting on January 25. See our updated FOMC 101 for a look at the voting members for 2022.
I keep this type of thing at hand so as to know who is saying what (not that ALL of them don’t matter) … And now you know… #FOMC 101
