On Tuesday, equity markets stumbled after a firm CPI print and upbeat commentary from the San Francisco Fed’s John Williams and Atlanta Fed President Dennis Lockhart seemed to suggest that a June rate hike might still be a possibility.
The triple digit decline on the Dow represented a return to a perverse dynamic created by the ultra accommodative policies adopted in the wake of the financial crisis. Good economic news is greeted with selling as traders assume that the era of easy money is set to come to an end. Obviously, there’s something patently absurd about the market’s obsession with the timing of the next Fed hike. We’re talking about 25 bps here. It’s largely symbolic. If the world can’t handle one more 25 bps hike then we truly are in trouble.
Nevertheless, stocks are having none of it. The equity market has become a “no hawks allowed” club. Here’s how BofAML summed up the situation:
“There it was again – the fear of rate hikes. What it took was the combination of better than expected economic data in the form of CPI and Industrial Production for April, and hawkish Fed talk as Lockhart and Williams stated that the June FOMC meeting is live and they expect the Fed to hike at least twice this year. In response the market implied probability of a June rate hike jumped to 14% from 4% and stocks ended down more than 1%.
“However we continue to think that over the medium term better US data is positive for credit spreads because the weak global economy still prevents the Fed from hiking rates.”
Right. In other words: the data doesn’t matter. This is all about trying to keep the entire global economy from imploding under the weight of what could very quickly become a vast policy divergence. It’s not so much that the US economy can’t handle another 25 bps. Rather, it’s about how another 25 bps would reverberate through global markets. If USD strength were to trigger capital flight from EM while simultaneously driving commodities lower, the boomerang effect could well weigh on the domestic economy.
On Wednesday, we’ll get a look at minutes from the Fed’s April meeting. Needless to say, they’ll be parsed for any indication that some voting members are inclined to move sooner than September. Here’s Bloomberg’s Richard Breslow summing up the questions on traders’ minds:
“Just how close the debate was? What was the intended nuance in the statement? How are domestic and international risks skewed?”
But the better question might be this: what happens if the FOMC catches the market wrong-footed with a June hike? For the answer, we go to Goldman, who is out today with a bearish call on equities:
“After the rebound from the trough on February 11, and with the S&P 500 at the upper end of its recent range, we downgrade equities to Neutral over a 12-month horizon, in line with our 3-month view.
“Given we do not see much value across asset classes and we see a variety of cross-asset risks, we remain Overweight cash near term.
“We believe the market’s dovish pricing of the Fed increases rate shock risk, in which case both equity and bonds could sell off.”
This is reminiscent of something Deutsche warned on last September. A Fed hike at this juncture risks creating a situation wherein everything sells off at once. Stocks fall as the monetary policy punchbowl is gradually pulled away. USTs sell off as expectations for higher rates outweigh buying by foreign investors who are increasingly desperate to escape NIRP. The USD rallies causing commodities and EM to slump. In short: there would be very few places to hide.
Meanwhile, the combination of jittery markets and a pervasive negative rates regime abroad has flattened the yield curve in the US. “The premium that investors receive for holding 10-year U.S. government debt instead of two-year notes fell to 0.94 percentage point [on Tuesday]”, WSJ notes. “The swings narrowed the gap between short-term and long-term rates sending it to its flattest reading since December 2007.” Needless to say, the closer we get to an inverted curve, the more worried the market will become.
In all likelihood, this will all amount to nothing in June, but then again, there’s quite a bit of pressure on the FOMC to prove that policy normalization is actually possible. As Citi’s Brent Donnelly put it earlier today, “as ridiculous as I feel getting dragged into yet another round of Fed hype after so many past failures to launch, it is hard to deny that there seems to be something going on here.”
Maybe. Or this could just be another example of the market being scared of its own shadow.