Another Fed meeting is looming large on the near-term horizon and the expectations have been pared back from a full percentage point move to a tried-and-tested 75bps. With the 10y Treasury Note hovering around 2.80% after a 50bp rally from the yield highs reached just a couple of weeks ago, it’s pretty clear that the fixed income market has embraced the signs of a significant coming slowdown, and believes, when push comes to shove, that a Powell-led FOMC will tilt dovishly. I will make the case for why the first assumption will prove correct, while the second is nothing more than wishful thinking among the Pavlovian minded population of bond traders. Unless, and this is a big unless, we’ll see a proper Powell pivot.
Having once again massaged the message towards a 75bp move (why?), Fed is now facing a Minsky moment. They are at the point where they have the ability to regain some leadership by getting ahead of expectations. Lifting the funds rate by 100-125bps tonight will achieve that – and a lot of other things. It would credibly demonstrate that they take their mandate seriously, allow them to actually sit back a bit and reflect, rather than be forced to move on auto-pilot. If they stick to the tried-and-tested, they will not tighten market conditions, at a time when inflation is six percentage points above the Fed funds rate, and they know they will also have to move again in September, barring a series of disastrous events between now and then. When you know you will have to keep tightening policy down the road, I struggle to make the intellectual case for why you wouldn’t do it immediately. It would also be wise for FOMC to revisit the Bernanke inspired rate-hiking cycle of 2004-06, arguably the biggest fiasco in modern Fed history, which pretty much embraced and encouraged the crazy, bubble-like behaviour which led to the Great Financial Crisis.
US and the world is facing an unprecedented cost-of-living crisis since the post-1970 era, which is basically driven by our inability to replenish the resources our planet keeps giving us. This price shock will not revert, though it might moderate somewhat, which means the pressures on society will remain brutal until demand has dropped substantially below trend. A 75bps move tonight does nothing to achieve this. What markets, the economy, and the climate requires is a Powell Pivot, recognising that facing all the above on the back-foot is a bad strategy, and only by playing an offensive game can Fed elevate themselves into a position where they can actually affect outcomes.
Financial assets at large will continue to find this a very tough environment, despite rallies in both bonds and stocks lately, unless we can effectively tackle Climate Change. Buy-and-hold strategies, fully invested portfolios, and positions held in the blind belief of a Fed put coming to the rescue will continue to deliver sub-par returns. Skilled stock pickers with a strong understanding of the macro environment will fare better, and this continues to be a fantastic environment for portfolio managers with the ability to generate pure alpha.
One thing is worth bearing in mind here. With Climate Change being the overall driver of portfolio returns in 2022, and a strong likelihood that this will remain the case for the foreseeable future, there is no way for any market participant to hide from it. For planetary health, no liquidity is infinitely preferable to too much liquidity.
