The market has a way of getting what it wants. And right now, it surely does not want Yellen to hike this week. Will she nevertheless, as is widely expected? Or will the buoyant markets force yet another delay, ultimately resulting in a ‘none-and-done’?
There’s no denying that the Fed policies fueled this stock bull market. The liquidity of QE 1 to 4 propelled the markets to new highs with every shot. At the completion of the QE tapering in October 2014, the S&P 500 hovered around the 2,000 mark. Today, we’re trading at exactly the same levels. No QE, no advance.
Leon Cooperman, manager of Omega Advisors, argues that interest rate hikes are positive for stocks. That might historically be the case. But this time around, things could be different. We know, that’s the most dangerous sentence in the world. But this is not your average business cycle. Nowhere near. The cumulative GDP-addition since the end of the financial crisis might be equal to the the point of prior rate hike cycles, as bond king Jeff Gundlach pointed out early last week. But there’s barely GDP growth to be found.
Also, inflation usually picks up in the late expansion of the business cycle. Commodities outperform as the slack in the economy diminishes. That’s the point where the Fed normally starts tightening. Right now, we’re looking at the worst commodity crash in decades. Inventories-to-sales are rising as well. The yuan is plummeting. There is just no slack.
What about the job market? Isn’t the unemployment rate at the 5% target? Well yes, it is. And at first glance, it’s looking much better than Europe’s 9% unemployment. But wait a second. If we adjust the unemployment for the participation rate, like GMO’s Jeremy Grantham did recently, we’re looking at worse employment figures in the US than in Europe. While even counting in Italy and Spain. You know, the same Europe where ECB-president Mario Draghi just put the QE-pedal further to the metal.
But the Fed seems to want to hike anyway. Why? First of all, there are two tools for monetary policy: words and deeds. And if you use too much of the former compared to the latter, you lose credibility. The Fed put itself in a corner. It is pretty much forced to act.
Secondly: the US elections are coming up next year. President Obama would like to finish on a positive note. And of course, he would like to see a Democratic successor. To that end, he needs to ‘build confidence’. And a rate hike is a sign of confidence – whether it’s just keeping up appearances or not. If you don’t believe politics matter: it was Obama himself who nominated Yellen as Fed chair in October 2013.
Now, let’s be crystal clear. These are not valid reasons for a rate hike. On the contrary.
To make matters worse, market conditions have already significantly tightened since mid-2014. The stress accelerated during this year, culminating in the high yield turmoil we’re currently witnessing. But it’s not just the the well-known HYG and JNK junk bond ETFs that are crashing. Another example is the BKLN Senior Loan ETF pictured below, which includes leveraged loans. There are some rumors of margins calls on total return swaps, which participants use to leverage loan portfolios.
Even spreads in investment grade credits are widening sharply.
We are on the cusp on a surge in corporate defaults. Does that sound like a good time to hike rates?
In August 2007, with the first mortgage shockwaves hitting the market, Jim Cramer of all people literally begged Fed chairman Bernanke to “wake up” and “open the discount window”. The CNBC commentator noted: “We have armageddon in the fixed income markets”. The stock market shrugged and made new highs in October, before slipping somewhat. It was not until early 2008 before the summer lows were breached. And it took more than a year for the market to eventually melt down.
Will the Fed disregard the current bond market turmoil, either on purpose or because of basic ignorance? Or will it hold rates steady yet again, forced by the high yield markets and making ‘none-and-done’ the new mantra? We will find out shortly.
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First published here: http://www.zerohedge.com/news/2015-12-14/will-market-force-yellen-none-and-done