Tick Tock Tick Tock…
By David Nelson, CFA CMT
On Wednesday last the release of FOMC minutes confirmed what investors and markets already know. The Taper Clock has started and the countdown to an inevitable tightening of monetary policy has begun. The sentence ‘ a number of participants suggested if the economy continued to make rapid progress towards the Committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing plan for adjusting the pace of asset purchases’ is exactly what you would expect from the FOMC. Lay out the case but leave open the possibility that they won’t pull the trigger. Will investors take it in stride as a responsible withdrawal of stimulus, throw a tantrum or something worse?
Jackson Hole is in August, a meeting likely to give us more information and a possible policy shift. For the last several months the message has been we’re not ready to think about starting to think about a rate hike. Ready or not markets have already started to react and maybe an explanation of the sluggish May on the heels of one of the best earning’s seasons I’ve seen in my career.
U.S. markets struggled last week while most of the world had a slight upward bias. Investors are still chasing return jumping from one secular trade to the next searching for the elusive Holy Grail. Year to date the pro cyclical value trade still has provided the most alpha but investors are reluctant to give up on their favorite Tech darlings. The challenge for growth stocks and other high multiple shares is the view they are considered long duration equity and by definition more at risk to a less accommodative Fed.
Last week’s CRYPTO crash hasn’t gone unnoticed by equity investors and maybe a sign that risk appetites aren’t as ferocious as they were at the start of 2021. Bitcoin entered the weekend down 45% from recent highs. The selloff in part was sparked by Tesla (TSLA) founder and CEO Elon Musk following an appearance on Saturday Night Live where he referred to Dogecoin as a hustle.
Over the weekend he did an about face tweeting his support for crypto over fiat currencies. Given the damage heightened concern expect increased volatility as we enter the trading week. Add the fact that 90% of SPACs that announced deals this year are underperforming the S&P 500 you have another clear signal that froth is coming out of the market.
Genie is out of the bottle
The catalyst for all the newfound concern is of course inflation or at least the perception sustainable inflation is on our doorstep. Home prices are surging and everyone reading this post knows their cost of living has been rising steadily. Economic activity is rebounding and across America employers are complaining they can’t get employees back to work without hiking wages significantly. You don’t have to be a rocket scientist to know what comes next.
For months both Treasury Secretary Yellen and Fed Chair Powell have said rising inflation is transitory and that argument has a lot of support from the analyst community.
Just last week a Goldman Research team put out a piece with the following message. Despite the largest increase in US core CPI in 40 years, we continue to see rising US inflationary pressures as mostly transitory in nature with limited impact on Fed policy.
We also had the opportunity to talk recently with Neil Azous Chief Investment Officer of Rareview Capital to get some insight into their thinking. Neil sent us the following.
- The Federal Reserve asks Primary Dealers to submit answers to survey questions, including the time required for the markets to absorb tapering and the first interest rate hike smoothly. The survey shows 9 months to the end of taper and 9 months after tapering concludes for the first interest rate hike. This is how the timeline was referenced in the FOMC minutes:
- “According to the median survey responses, the Federal Reserve’s net purchases of Treasury and agency securities were expected to end three quarters after the first reduction in the pace of asset purchases, and the first increase in the target range for the federal funds rate was expected to occur three quarters after that.” (LINK, see Question 5)
- Therefore, if you have a September start of tapering plus 9 months to the end of taper plus 9 months before the first interest rate hike, you end up at Q1 2023.
The above may prove true and that there’s plenty of runway before we have to worry but last week’s minutes at the very least show the Fed is hedging their rhetoric. They now believe it is important to start the clock leaving their options open for some type of shift in policy later this year.
The only question for investors: What can we expect when the clock runs out and the ticking stops?