Twitchier than a cat on a hot tin roof...

 

ref :- "There was no hawkish surprise" , Unhedged , My FT, The Financial Times, 22/6/21

ref :- "The reflation trade lives" , Unhedged , My FT, The Financial Times , 23/6/21

The FT publishes a rumination titled "Unhedged" that you can access in its My FT section, penned (usually) by Robert Armstrong. The daily newsletter is an "Opinion" piece, and the clue is in the name... it's just one person's opinion. It's your right - and very possibly your job - to agree or disagree with the views expressed as you think fit. But it's well worth dipping into this and other such pieces... they're generally both interesting and informative. Even if you are not in tune with the conclusions being drawn, they might at least give you a useful insight into how those positioned on the other side of the market are thinking.

As it happens, we think Mr Armstrong's pieces so far this week make a lot of sense. Of course that's a very different thing from saying one should be making any trading decisions based on these articles, but as a guide to the skittishness of today's markets - with valuations endlessly extended by the promise of unbroken largesse in the Fed's monetary policies - they're a helpful reminder of how markets currently work, for better or for worse and not always obeying the logic suggested by a colder, more distanced analysis of events.

It's a subject we've visited before. Yesterday's letter, written on Monday, discussed last week's action, when markets went into reverse as a result of seemingly hawkish comments from the Fed after their monetary policy meeting. The rhetoric was certainly stronger than many were expecting, or perhaps more to the point hoping for, but was it really hawkish? The piece was subtitled " Shocked by the obvious", which one could say gives you all you need to know about the direction in which the article was headed. But for good order's sake:

Even the frothier of market bulls already knew that the Fed was going to start discussing when might be appropriate to begin tapering the massive QE bond-purchasing programme designed to suppress longer rates - discussing mind you, not taking action. A majority expect an announcement next quarter. But what was not widely in the forecasts was what revealed in the Fed's dot-plot, the chart of interest rate predictions from the members of the Fed's Open Market Committee. Previously, the consensus had been that there would be one rate hike in 2023, probably in the second half of that year. Now, a growing proportion of the committee see two hikes in 2023 and some see one coming towards the end of 2022.

The result? A sharp reversal of the Reflation Trade, extending a move that has been weighing on traders' minds for a few weeks now. In other words, a switch out of cyclical stocks (financials, industrials, energy) and a flattening of the yield curve with rates rising at the short end in comparison with longer-term Treasuries, which also benefitted from something of a flight to safety.

We've talked many times about the problems of a lack of liquidity after unexpected developments. When too many flighty, short-term investors attempt to unwind their positions at the same time, moves will be exaggerated. It's all very well pointing to high total volumes, but that's NOT the same thing as liquidity - the ability to enact trades at a certain price - and a lack of liquidity certainly contributed to last week's action. But Mr Armstrong's point is that if you were of the bullish view, did the Fed really say anything that should cause you any kind of palpitation?

With regard to a future tapering of QE, that can be ascribed to a strengthening employment picture. And as far as short-term rates are concerned, the Fed's CURRENT posture is unchanged, relaxed about inflation and even an overshoot of the 2% target because it's "transitory" , don't you know? Any central bank must evolve its monetary policy according to data and looking beyond volatile consumer price indices, with the recovery steaming ahead and things like property values and commodity prices still so high it would have been irresponsible of the Fed not to acknowledge that at some stage a gentle touch on the brakes may have to be applied. But we're talking of the possibility of a small rise within eighteen months, and two more within 2 1/2 years... it's hardly Volckeresque, for goodness sake.

Note: Paul Volcker, Chairman of the Fed who defeated rampant inflation in the 1980's with sky-high rates (19%) but inevitably brought on a recession.

Which is to say, the Fed said nothing that should have surprised or panicked any sensible investor (though we suppose that given their doggedly laisser faire utterances on inflation up until now SOME will inevitably accuse the Fed of poor communication). Over the longer term, an irresponsible Fed is far more damaging to markets than one that would allow uncontrolled inflation. But the fact is that a substantial and influential slice of today's investors are neither long-term nor, some of the old sages would suggest, particularly sensible - even if a lot of them have made a lot of money.

More to the point, at this precise moment, the Fed is still epically dovish, even if that continues to upset many bond market gurus. Rightly or wrongly as far as the reflation trade goes, "If you believed in it a week ago, believe in it now".

Which, funnily enough, is the subtitle of today's Unhedged newsletter "The reflation trade lives", written yesterday after markets had largely righted themselves. This too is well worth a read, listing reasons why the trade may or may not be still a good idea. But if you only take one thing out of the two pieces, it should be this:

It's not something we all didn't know but we need to be reminded of regularly : many of today's hyper-extended valuations are sustained by the oxygen of historically dovish Fed policy. It's almost as though a significant proportion of market players have come to expect it almost as their right, and for it to be continuing. But whilst it would never seek to undermine markets, maintaining market prices is NOT part of the Fed's job. They have other priorities which may include taking steps that will not be to the liking of flightier investors. In those circumstances, it seems likely (and sensible to expect) some regular and bloody market reverses - much bloodier than the little blip we've just seen.