What to expect from the Fed?
A pronounced, hawkish tilt, consistent with the dramatic shift in rhetoric and language that’s been at play since November, both from Powell himself, and the other Fed members.
Recall that the word “transitory” has been retired.
Recall that the framing is “full employment is best achieved through price stability”.
Recall that the set up is to double the pace at which the taper accelerates, which acts (in the mind of the market, at least) to pull forward the timing of rate hikes.
Larry Summers is suggesting that the Fed signals “4 hikes” over 2022 as a message to the market. We are not so sure that the tone will be quite that aggressive, but we certainly see the Fed endeavouring to remind the market that the time for emergency settings has passed.
The evidence for tightening is writ large in the movements of macro market variables. The US dollar is higher, the term structure of rates has flattened, commodities have declined, spreads have widened, risky assets like equities have (at the least) paused, and real yields are higher.
Those patterns are exactly what economic theory tells us to expect in the face of an exogenous monetary shock.
Expect to see more of the same, post the conclusion of the Fed’s meeting. As such, we are modestly underweight equities and fixed income, allocating to cash and alternatives (where the correlations to such macro factors are either low or negative).
You might imagine that Omicron would give the Fed pause. That’s certainly possible, and a reason for not going much harder on our underweight to fixed income (which of course you would do, if you were certain that the Fed wanted to reprice the yield curve).
The Fed’s growth (employment) mandate is now somewhat in conflict with the price stability mandate. Omicron (or rather COVID) at first had a powerfully disinflationary impact, as the decrease in demand was felt globally through both volume and price. However the labour market impacts, and the supply chain bottlenecks associated with COVID since then, have proved somewhat inflationary.
As such Omicron is not a clear cut decision for the Fed, and further, the belief or faith in Anthony Fauci (the Chief Medical Advisor to the President) is strong. Currently, Fauci is “cautiously optimistic” on Omicron, noting the increased virality is seemingly matched by its decreased severity, and that sort of view is likely to give the Fed licence to look through/past Omicron’s demand side impacts, and instead to focus on what is currently an otherwise strongly-performing-indeed-overheating economy.
From a local perspective, the market positioning ahead of tonight seems to be favouring Value stocks (where we have a DAA overweight), with many of the market’s more beaten up stocks performing well.
However it is in the day’s underperformers, that we see the message more clearly.
The software companies, tech more generally, healthcare, fin tech, and other secular growth narratives are well represented in this list.
We remain underweight all of those names, and feel that the secular growth winners of the past year are all markedly overvalued.
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