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The Fed and mission impossible...
Looking into September...
For markets the next hurdle comes with the question of when/if/how much the Fed begins the tapering process. The Fed, since the crisis last year, have been buying $120bn of bonds (Government and Mortgage Backed Securities) every month. This provides liquidity and stimulus to markets. Tapering refers to reducing its purchases each month.
Some dates for the diary –
- 26th of September sees the start of the Fed’s ‘offsite’ at Jackson Hole. This is an opportunity for the Fed to talk more medium term. Financial stability (historically high equity valuations) and crypto may be topics that are discussed publicly.
- The next Fed meeting begins on the 22nd of September. This is likely the first opportunity for any kind of taper/reduction in bond purchases to be announced.
Ultimately the Fed face an almost impossible task. The last taper under Ben Bernanke in 2013 caused significant volatility. Lessons will have been learnt and with Chairman Powell likely to leave the committee in Q1 his motivation to avoid similar market dislocations will be heightened. The economic picture remains challenging, and the political picture gets more volatile with US Mid-terms in early November 2022 and last week President Biden effectively shooting himself in the foot over Afghanistan (his approval rating keeps moving lower). We are 12+ months out of the crisis but the dust hasn’t settled, and we/they have little idea of the permanent or semi-permanent scarring that will have been inflicted on the economy i.e., will the traditional retail sector ever fully recover? or commercial real estate etc. Ultimately the economy needs a weaker currency and a steeper yield curve (which makes lending more profitable for banks and hence, in theory, their willingness to supply credit) to see re-shoring and business investment.
The consumer however remains key. Over the last year disposable income and hence spending have been more than supported. Savings rates are now starting to normalise. The graph below, however, is worrying.
These indices are from the University of Michigan which is a very well-respected source of economic statistics. The three lines show the buying conditions for big ticket items i.e. houses, cars and large household durables. The takeaway is that big ticket consumer spending has fallen off a cliff to historic lows (I can take the graph back to 1980 and only then see worse levels). This is clearly one data source, and we shouldn’t draw too many conclusions. However, I suspect this is a combination of the realisation of government cheques ending combined with the natural reaction to used car prices (and housing) rising 20% this year and the lack of supply of new cars. Additionally, from several sources, this could also be individuals reacting to employer mandated vaccine mandates e.g. in California healthcare workers are required to be fully vaccinated by 30/9/21. After that, individuals will receive 5 days unpaid suspension. If they don’t get an initial vaccination in this period they are terminated on October 6th. This is apparently prompting early retirement and a decline in student nurses/lower paid workers. If this is echoed across other sectors the potential disruption to US domestic supply chains and political stability is large. Another headache for the Fed to decipher and a risk.
In summary - The Fed balance sheet is only going to expand which is ultimately positive for risk assets on a medium-term basis. As briefly described the underlying economic and political picture is a lot more fragile than what I think consensus is telling us. If the Fed begin to taper it will be in baby steps as the Fed Chair changes in Q1 and the US midterms hit in November 2022 over and above letting the dust settle on the economy. If they make a mistake the USD and volatility will rise and they will simply be forced to reverse course pronto. Bitcoin is up 60% in the last 30 days which is perhaps one indication that the Fed is maybe more likely to push out any tapering announcement to a later date.
It feels like investors are sitting on cash and cautious/neutral. This makes a Fed mistake type ‘crash’ more unlikely (clearly it can still happen!) however the year to date returns are very attractive and uncertainty/volatility are clearly rising. Perhaps this keeps markets more directionless for the time being until we get Fed clarity but ultimately there is no alternative and risk assets remain the most likely outperformers. The risks remain and indeed the lack of strategy and leadership regarding Afghanistan has increased geopolitics as a risk. On the other hand can we assume that the lack of leadership makes any further stimulus plan less likely or more likely because its domestic ? It’s not a base case but IF Beijing has any plans for e.g. Taiwan the odds surely have narrowed given the weak reaction from President Biden with clearly no communications with their so-called Allies.
n.b this is not meant to be, in any way, a pro/anti vax discussion purely macro analysis and highlighting of the risks.
agosto 26, 2021
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