Too Clever By Half
by Guy Haselmann, Director, Capital Markets Strategy, Scotiabank GBM
· Yesterday I received an email from a well-known hedge fund manager which in its entirety read as follows: “At the end of the day, the Fed is confused and confusing, so if you spend too much time addressing their comments you end up confusing as well”.
· In this light, I will detail one observation in this note that leaves me to conclude that the post-FOMC market reaction is farcical. Bear with me while I explain.
· The FOMC meeting was slightly hawkish for two simple reasons.
o 1) The Fed slightly moved forward its time frame for the first rate hike to the April-June time frame when Yellen stated, “It is unlikely the Federal Open Market Committee will raise rates for at least the next couple of meetings”. This statement is indeed wishy-washy enough as to allow the Fed flexibility around the comment; nonetheless, the center point for ‘lift-off’ was moved forward.
o 2) Yellen said the drop in the price of oil would have a transitory effect on inflation and was seen as “tax cut” for the consumer and businesses.
· These were the only new pieces of information that emerged from the meeting. How would a day-trader have reacted in normal markets? The US dollar would have risen. Oil would have fallen despite the rise in the dollar. The front end of the Treasury market would have dropped (i.e. higher yields). And, equities would have gone down. All of these occurred except for equities which exploded higher in wild grab-fest fashion. Why?
· The explanation centers around the fact that the Fed left the words “considerable period” in the statement, even though the Fed changed how it used those words. Many headlines read, “Fed kept considerable period”. This is misleading. The FED did NOT say that it “expects to maintain the target range for the federal funds rate for a consider time”. Rather, the Fed kept the original language that it expects to maintain the target…..for a considerable time following the end of its asset purchase program in October. There is a big difference between the two.
· Why make it backward looking? Using the statement in this manner is no different than saying, ‘we still believe what we said at the last meeting’. The markets already knew the Fed expected rates to be maintained after the end of QE, but what about its assessment from today forward?
· They actually even changed how the words “considerable time” were used to make them completely meaningless. They wanted to emphasize the word “patient” (even though the market already knew it would be patient). In order to keep the “considerable time” words, the FOMC said its patience is consistent with that earlier statement of “consider time”. If they did not do this in order to purposefully make sure those exact words were in the statement, then the entire sentence is completely meaningless.
· The reason the Fed likely went to such “too clever by half” efforts to make sure those words remained in the statement in tact is because they knew the press, HFT (high frequency traders), and algorithmic models would data mine those words, triggering a buy signal. With market liquidity so compromised, HFTs can push markets around easily and they certainly did.
· The Fed is very nervous about disrupting the apple cart after (arguably) fueling asset bubbles, so whenever they do anything hawkish, they cleverly try to also serve-up something dovish to the markets. I called this the “Great Aunt Addy Strategy” in my August 18th note in memory of my Great Aunt Addy who drove with one foot on the accelerator and one foot on the break.
· The Fed did the same thing earlier this year, when it simultaneously pared the QE program (hawkish), while offering ‘forward guidance’ (dovish).
· At the end of the day, the statement was hawkish. Most risks seekers I speak with say they will stay as aggressive as possible until the Fed hikes rates and then they will “get out”. This is the greater fool theory to believe the market is deep enough for so many to “get out” at the same time with poor liquidity conditions.
· I remain a bond bull. Most roads lead to a win-win for long dated Treasuries. If the Fed hikes early, I expect it will upset risk-on trades and flush people into Treasuries while reassuring that inflation will remain in check. If they don’t hike at all in 2015, I suspect it will reflect global anxieties or a problem that morphed from the many troubles brewing abroad. This may lead to fears of a broader slowdown prompting yield seekers to act more cautiously and gradually migrate to Treasuries.
· It is time to cover Treasury shorts in the front end and unwind flatteners (our strategy into the FOMC meeting). The market is giving active managers a great opportunity to go outright long the backend of the Treasury market at these post-FOMC improved levels. PM’s should also use this opportunity to take down low-quality credit and beta risk. Stay short oil. And yes, sell equities. For long only investors, I advise sector shifts in defensives like healthcare, staples and utilities. There are also certain financials that will benefit from a Fed rate hike that looms in early 2015 (this is only a short term trade).
· Unfortunately, the markets’ outsized and illogical reactions are signs and symptoms that financial markets are broken. The FOMC’s meddling in financial market behavior could easily catch up to them in an ugly fashion.
· “The world is just illusion, always trying to change you.” – VNV Nation
Regards,
Guy
Guy Haselmann | Director, Capital Markets Strategy
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Global Macro Commentary Dec 19
