Yesterday’s FOMC release was not much of a surprise. I viewed the broad price action (stocks, bonds, commodities down, dollar up) following yesterday’s release as more likely due to complacent positioning than a real reaction to something new. Perhaps there was a slight hawkish shift, though that’s no surprise given that the S&P 500 had rallied 8% in a straight line into the event. Goldman’s take:
The FOMC statement yesterday was just a bit more hawkish than expected, no longer listing tighter financial conditions as an explicit worry, and with no shift in the language to indicate more directly a later expected date for tapering.
While the language shift was there, it did not feel strong enough to indicate a taper in December, though reading between the lines on the Fed this year has been like reading legalese from the 17th century. However, fellow trader Romeo, writing at The Buttonwood Tree, made some solid points in his post yesterday about Janet Yellen as the new Fed Chair:
What makes me nervous about the here and now is that the Fed has to be seeing all the same signals I’m picking-up. Some examples:
- Margin debt
- Corporate leverage
- Momentum stocks
- Lending standards- subprime consumer and leveraged loans
- Investor sentiment
People talk about Janet Yellen like she’s a perma-dove, but they also forget that she was a lonely Cassandra in 2005/06, warning unto deaf ears of the economy’s excesses during the housing bubble. In a black and white world, her convictions for extraordinary monetary policy may categorize her as a Keynesian, but her trackrecord suggests she’s a bit more of a moderate. Perhaps she’s a realist who listens to her data, finding her signals through the noise–as opposed to pushing her dogma like her predecessors. Perhaps she nips capital markets’ excesses in the bud this time. Once bitten, twice shy? With the pang of our last credit crisis still so fresh in the minds of many, I think we have reasonable grounds to expect as much–given a recency effect and experiential hindsight bias beholden to regulators.
Nonetheless, that characterization of Ms. Yellen is mere speculation, as is trying to game the Fed’s psychology. The only value of this thought exercise is in acknowledging the potential scenario, probabilistically weighting the outcome accordingly. Accordingly, we should reduce out risk-asset overweight to benchmark-weight as we approach December–all else being equal.
While I don’t get the sense that he thinks a taper in December is likely, his well crafted point is that the market is putting close to a 0% probability on it, when it should be higher.
Similarly, Tim Duy also reached that conclusion after reading the FOMC release:
I fear I need to re-evaluate my conviction that March is the earliest to expect the Fed to begin tapering asset purchases. That conviction was largely based on the belief that the Fed needed to see both stronger and sustainable data to justify tapering. But the bar might be much lower, with only sustainable data necessary. In other words, the Fed may pull the trigger on tapering if incoming data simply suggests the economy is not falling over a cliff. Thus December and certainly January may be more alive than I had believed.
I’ve noted before on many occasions that I don’t think QE has much practical impact, but the psychological impact on the market is massive. We saw that earlier this year when the word Taper became all the rage. I still think the chances of a Fed Taper in Dec or Jan are quite low. But perhaps the market’s expectations are too complacent. If Fed governors do start hinting in their speeches that Dec or Jan might be an appropriate time for the Taper, then the markets might get another bout of indigestion.