The 10th Man: Fed Rate Hike It And Like It by Jared Dillian
Lots of folks are throwing roses at Janet Yellen for her rate-hiking performance yesterday. They pulled it off without a hitch. Like the Ocean’s Eleven heist—everything had to go right, and it did.
Stocks rallied hard, FX had it fully priced in, and the only thing that was down was oil. Even the junk bond market caught a break. You couldn’t have scripted a better ending.
Except this isn’t the ending, but the beginning.
Also, I’d like to reiterate that the Fed has been screwing around with this for over a year, to get the market used to the idea of a 25bp rate hike. I don’t call it a success when you need a year of jawboning to raise rates a quarter-point. I call that hopelessly inept.
Anyhow, I think the takeaway for investors here is how hawkish the Fed is and how rates might go higher, faster than we thought. Many people thought the directive was dovish. I didn’t think so at all.
- The Federal Reserve talks a lot about labor utilization slack being taken up—that’s code for “If the unemployment rate goes down any more, we are going to look stupid for not having hiked rates.”
- The Fed seems confident that inflation will rise to 2%. Why, I’m not sure.
- The whole directive has a hawkish tone.
- The Fed emphasizes that rate hikes will be “gradual,” but it’s still targeting 1.4% fed funds at the end of 2016, which would entail 3-4 rate hikes next year.
- The Fed doesn’t seem to be at all concerned that it’s an election year.
Economists are focusing on the word “gradual,” taking that to mean that the Federal Reserve will be very cautious, but if you’re hiking four times in a year, you’re hiking pretty much every other meeting, and I don’t see any flashing lights in the directive that might indicate the January meeting is off limits.
Nothing seems to be off limits.
Having said all that, I do think the Fed will significantly undershoot its target for 2016 fed funds (it certainly won’t overshoot it), so there is still money to be made, but the big takeaway is that this is not a one-and-done Fed.
In my Street Freak letter and my premium publication, The Daily Dirtnap, I did correctly predict that the Federal Reserve would hike and that risk would rally, but I did not anticipate how hawkish the tone had turned within the Fed.
Pretend that fed funds really do get to 1.4% at the end of 2016. Where do you think the following currency pairs will be?
EUR (rates -0.3%)
CAD (rates 0.5% and dropping, possibly going negative)
CHF (rates -0.75%)
JPY (rates 0%)
SEK (rates -0.35%)
Etc. This is like currency trading for dummies. The dollar is going higher.
And if the dollar goes higher…
…more pain for commodities and emerging markets.
In other words, back to the salt mines.
This could change, if the Federal Reserve dilly-dallies, or credit doesn’t cooperate, or something pushes back the rate hikes, but it is entirely possible that even more pain will be piled onto the enormous steaming pile of pain that has been heaped on commodities already.
On the other hand, gold didn’t get killed yesterday, which is a start.
Someone cited an old Buffett quote on Twitter yesterday, about how he never, ever took what the Fed was doing into account with his investment decisions.
And then you have Stan Druckenmiller in the Lost Tree Club speech, saying that the first thing he looks at when investing is what the Fed is doing and the liquidity situation.
Whom are you to believe?
I believe Mr. Druckenmiller—hands down. Especially in today’s environment, where central banks play a much more active role. Liquidity drives everything.
Getting back to what I was talking about earlier, the Fed is getting credit for hiking rates without upsetting the market.
I remember a time when the Fed didn’t give a crap if it upset the market. If you recall, we used to have surprise, intermeeting rate hikes. Oh Em Gee, can you imagine what would happen if they did that today? Pandemonium.
Greenspan started this whole transparency kick, and Bernanke expanded it even further. It is counterproductive. If you’re going to have a central bank with a monopoly on interest rates, have it operate in secret and drop bombs on people, like the Fed described in the book Secrets of the Temple.
Forward guidance is actually a trap for central bankers. You give the market expectations, you risk disappointing it later if you change your mind. The gnomes haven’t figured this out yet.
People think the Fed is “omnipotent” and controls the markets. Nothing could be further from the truth. Today’s Fed is held hostage by the markets. If it weren’t, it rightfully would have raised rates 18 months ago, and we’d be at 3% fed funds right now.
I asked rhetorically the other day—when was the last time the Fed hasn’t come to the rescue?
You have to go all the way back to Paul Volcker, who to this day is in Central Banking Cooperstown. History has a funny way of not looking kindly on the doves. That applies to any central bank in any country, throughout history. Toughness is a virtue.
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