H is for Hawk

If the appropriate literary allusion for last week's ECB was "How do I dove thee?", then the equivalent for yesterday's FOMC announcement was H is for Hawk.  To be sure, by the standards of previous tightening cycles the fare on offer from the statement and the press conference were pretty anodyne; given what we've heard from Yellen since her ascendancy to the head of the FOMC, however, it was fairly stirring stuff.

Contrary to expectations, the median Fed funds plots for the next couple of years were ratcheted up despite little net movement in key macroeconomic variables.  Of course, it subsequently emerged that some forecasts were made with the assumption of looser fiscal policy and some were not, which sort of renders the whole exercise somewhat meaningless.  And in fairness, in one of her less-hawkish moments, Yellen couldn't resist pooh-poohing the shift in the Fed funds projection, calling it minor.

This, of course, raises the larger issue that if the Fed doesn't want the market to fixate on the dots, why include the bloody things in the projections to begin with?  When the FOMC was trying to promise perma-ZIRP, they were a useful tool with which to illustrate their intent for the visual learner.  These days, however, the most notable effects of the dot plots is to increase uncertainty and reduce Fed credibility.

Speaking of which, Yellen also walked back on the "high-pressure economy" language that she seemed happy to flirt with a few months back.   Given that that idea provided cover to err on the side of inaction despite improvement in the economic fundamentals, her dismissal of the concept suggests a somewhat more activist reaction function than had previously been the case.

Similarly, she also dismissed the necessity of easier fiscal policy, a prescription she was happy to provide earlier in the year.   To be sure, she had already started the retreat from this posture a few weeks ago, so this wasn't quite as new as the rejection of the high-pressure economy stuff.   Still, it does suggest that an injection of fiscal stimulus would present at least token risks of over-heating.

These are what you might call more mainstream views, rather than the overly-cautious dovishness that has characterized Yellen's approach to policy for the last several years.   What's changed?   Well, an obvious factor has been an abrupt shift in the (expected) political trajectory.   While Yellen once more took pains to stress the apolitical nature of the Fed, a cynic might reasonably question why what was apparently good for the goose is not, in fact, good for the gander.

Equally, a cynic might raise the question of why anyone should believe a dot plot projection calling for 3 hikes next year.  After all, this time last year the Fed was calling for 4 in 2016 yet delivered only the one.  "But there were extenuating circumstances!" you cry.  Fine.  Still, at the time of the last Fed meeting would you have bet on only one rate hike this year knowing that the ensuing 12 months would bring:

*  9.2% total return for the SPX
* 0.18% increase in 10y yields
* 14.5% total return in high yield corporate debt
* 40% rise in oil prices
* 188k per month rise in payrolls and the unemployment rate at 4.6%
* Core PCE price index rising from 1.3% y/y to 1.7% y/y

Macro Man wouldn't have, and yet it happened.  That being said, the market can go a long way in pricing more rate hikes.   If we look at the 13th vs the 1st Fed funds contract, we can see that the market is currently pricing in only about half of the rate hikes over the next year that it was in the middle of 2015, and some 30 bps less than was priced at the beginning of this year.

Macro Man ditched his recent bond purchase as Yellen was talking.   Just because something is a nice set-up for a trade doesn't mean that the trade has to work, and in this case it didn't.   Looking at the chart of EDZ8, yesterday's price action doesn't exactly look like a market heading for an imminent reversal.

Nor indeed does USD/JPY, which has unsurprisingly ripped on the prospect of tighter monetary policy and is currently threatening to hold a break above the big neckline.

EUR/USD is also threatening the lows of the entire down trade, and the divergent policy orientations of the Fed and ECB makes a parity party look likely once again.

Macro Man had a little chuckle in the press conference when one of the journos asked about equities, noting that Dow 20,000 is a foregone conclusion.   While it would certainly seem like it statistically, given the rising prevalence of SPX RULZ! SHORTZ R FULZ!  spam in the comments section, it would be a sort of karmic justice if this presumption were to prove misguided.

More prosaically, the impact on equities from a tightening of monetary conditions caused by a shift in the perceived Fed reaction function could be vastly different from that caused by a presumptive shift in fiscal policy.  The latter is arguably growth positive on net, while the former clearly is not.  Given the degree to which financial conditions have explained equity performance over the last half-decade, a tightening should be viewed with some degree of trepidation.

At least until you see Yellen's face break out; the  you'll know she's started eating too much of this.