“Everyone’s Praying But No One’s Believing” – The ‘Fed Put’ Is Dead
Chalk Outline
Yellen’s detailed speech initially triggered an out-sized market reaction. Unfortunately, it was mainly due to shallow market depth and weak-hand positions. The ‘risk-on’ trades that ensued seem driven by positional unwinds from short-term traders. These markets will likely reverse back to lower prices once those initial trades are digested.
Yellen’s speech should quickly begin to hurt over-priced financial assets. The stellar performance of financial prices over the past several years has primarily been driven by central bank accommodation. The double digit average returns (15%+) of the S&P 500 from 2009-2014 was not driven by economic strength, but rather by massive global central bank actions. There is simply a poor correlation between economic activity and the S&P 500 in any given year.
Since the Fed’s balance sheet flat-lined in 2014 (with the policy rate locked at 0%) risk assets have chopped side-ways-to-lower. Therefore, a sooner (than priced-in) removal of accommodation should be hurting, not helping, risk assets.
The looming 2015 rate hike, threatened by Yellen and other FOMC members, is desirable and plausible in their eyes due to several factors:
1) confidence that the US economy is on firmer footing and has moved materially away from crisis conditions;2) a sense of desire and urgency to move off the ‘zero lower bound’;
3) anxiety about not having any ammunition during the next economic downturn;
4) fear of missing the business cycle and with it the opportunity to move off of zero rates, and;
5) as stated in Yellen’s speech, the potential that holding rates too low for too long “could encourage excessive leverage and other forms of inappropriate risk-taking that might undermine financial stability”.
Yellen’s speech was the first time I can ever remember a Federal Reserve Chairperson commenting that inappropriate risk-taking might be undermining financial stability. This is explicit confirmation that the Fed’s aim of lifting asset prices in the hopes they bolster broader economic activity has reached the end of its useful life. Barring a financial or economic disaster, the ‘Fed put’ has been put out to pasture.
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