You usually see stars when you get punched in the head. But it is 2021, and all things are possible, so the punch in the belly (of the curve) after the Fed meet had folks seeing dots – moving dots.
That is fine. It usually passes after a few seconds. But in this case, the moving dots have generated tons of press and a fair amount of cross-asset volatility.
My question is, why? The dot plot has been one of the most unreliable indicators – it is simply various governors’ guesses about where rates will be some time in the fairly distant future. Compounding that, the current dot plot was generated amid spiking economic indicators driven largely by base comparisons that are no longer valid (at least in CPI terms).
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You usually see stars when you get punched in the head. But it is 2021, and all things are possible, so the punch in the belly (of the curve) after the Fed meet had folks seeing dots – moving dots.
That is fine. It usually passes after a few seconds. But in this case, the moving dots have generated tons of press and a fair amount of cross-asset volatility.
My question is, why? The dot plot has been one of the most unreliable indicators – it is simply various governors’ guesses about where rates will be some time in the fairly distant future. Compounding that, the current dot plot was generated amid spiking economic indicators driven largely by base comparisons that are no longer valid (at least in CPI terms).
Chair Jerome Powell said we should ‘take the dot plot with a big grain of salt’. Despite that, it has been elevated to gospel, showing the Fed has abandoned its FAIT strategy, will not be data dependent and will move aggressively to quench inflation. This in turn was taken to suggest inflation will indeed be ‘transitory’, as the Fed has suggested. Talk about squaring the circle.
A second question is, why would the Fed act aggressively if inflation is indeed transitory? To me, that smacks of a setup for my sharp US growth slowdown bear case.
This apparent conclusion has led bond investors to sell the five-year belly of the curve and buy the long end. Real rates have rallied, though remain quite negative (-0.8% on the 10-year). Gold and steepener trades have been crushed. And the vaunted 10-year? Well, it is essentially unchanged on the week.
Other assets moved too. The equity reflation trade was deemed adversely affected despite little likelihood of a change in taper timing (pre meet, 72% of BoA FMS folks saw tapering announced in September, and that is still the most likely case). Cyclical and value have been sold, while growth stocks were bid. Nasdaq even hit a new all-time high on Thursday. Rotation, rotation, rotation – or as we call it at TPW Advisory, ‘the twin-engine market’.
European equities have been sold, though that seems more like healthy profit taking given the Euro Stoxx 600 was on its longest winning streak since 1987! A little pullback here is good.
Commodities are off greatly, with the grains having their worst few days since the GFC after being on fire in the preceding weeks. Traders have pummelled the industrial metals in anticipation of Chinese stockpile releases. Funnily enough, the commodity selloff is being seen as validating the transitory inflation thesis. I think commodities are the latest little bubble to be popped before things get out of hand – that is healthy behaviour.
Even the USD has got in on the act, bouncing nicely against the majors as the big USD short position gets toasted. EMFX has held up well, with the Brazilian real up versus the dollar as Brazil does more than plot dots – it raises rates. EM’s Fragile Five are in much better shape than in the 2013 Taper Tantrum.
So, what does it all mean? Do you have to go into the concussion protocol and not play – take the summer off, as it were?
I still expect a shift from a staggered reopening to a synchronized global recovery as we move through 2H 2021 and enter 2022. I see this as USD and UST bearish and bullish for non-US equity, commodities and thematics.
I do not believe the Fed has abandoned its AIT approach by any means and think coming months will present a cleaner data set that allows for further analysis and ‘testing times’.
We are all macro investors now, and the focus will shift to the passage of President Joe Biden’s jobs and families plans. This in turn will impact the inflation, rates and cross-asset outlook. I expect passage along reconciliation lines.
Such passage would mitigate my bear case. It would unleash the potential for above-trend US growth stimulated by procyclical Biden policy and a long-overdue capex cycle (public-private capex/GDP at multi-decade lows) supported by an incipient productivity surge that limits the inflation risk.
That is a constructive outlook. It is also one in which the Fed becomes more of a bystander than a major player, but a bystander with the capacity to throw a spanner in the works if it tightens too soon and too aggressively.
Time will tell, as always. Meanwhile, I suggest reviewing the long-term charts and noting where we are in the leadership shifts (early), listening closely to the Fed speakers in days ahead, and observing next week’s trading behaviour after the weekend’s thinking time.
It comes down to this: if you think the Fed will act aggressively, you can buy the long end of the UST curve, the dollar and growth stocks. If you do not, then do not – buy the value stocks, non-US equity and commodities that are being offered at some nice entry points. I reviewed the technical positions in our two model portfolios, and they remain sound. Supportive J.P. Morgan work on stock-bond flows coupled with the Goldman Sachs Financial Conditions Index in uber-easy territory supports my remaining in the latter camp.