As everyone gathered around the Christmas tree, ordinarily all screens, tablets and iPhones would be switched off at this time of year. But not yesterday. At the eve of one of the most widely watched FOMC meetings ever, Fed Powell delivered one of the most precise, perfectly calculated and articulated message ever. Just enough to keep the market going and defer to powers beyond him. A message that showed support of the economy and the central bank's plan, despite slowing growth and risks mounting, but more importantly, showing independence from political pressure.
The Fed raised rates by 25 bps in December, which was a forgone conclusion. There was some whisper that he would pause at this meeting. As encouraging as that may sound, investors need to be aware, that if that were to happen, it would not have been a positive outcome. As the old adage goes, "when the Fed panics, the market panics more!"
The market was expecting an entirely dovish message in the commentary and press conference that followed. Instead, Fed Powell surprised the market and suggested there would be two more rate hikes for 2019 (down from three), but the implied Fed Funds market curve had been pricing in less than 30% probability for even one rate hike next year -- hawkish on the margin! The dollar rallied, as one would expect.
Rather than focus on the very short term, as traders debated what to buy or sell in the next second, taking a step back, the key message to take away is that the Fed is monitoring the risks carefully but also cognizant of the robust economic data and the task at hand -- unwind the Fed's balance sheet that has created this "Everything Bubble" since 2009.
Investors have gotten used to mere Fed followers, like Yellen and Bernanke, that just stuck with the system and gave what the market wanted, not what it needed. But why must we operate in emergency/full stimulus mode when the economy is growing at around 2.5% GDP and assets are still about 300% higher than a decade ago? This is what Powell is focusing on, slowly ridding the market of the free money while it is able to grow on its own, so that when the next crisis comes, the Fed has some room to manoeuvre. Unless people thought this debt bubble can go on forever, just keep printing more and let the next generation sort out the mess.
The media will be filled with angry tweets from President Trump and how "disappointed" he is with the Fed. Dare I say, Powell is probably one of the best Fed chairpersons we have had in the longest time, doing what the Fed should do, rather than just deal the cards his predecessors gave him and go with the flow (Yellen?). Everyone wants a Santa rally, and it is so easily achievable. If President Trump just backed off the ridiculous Trade War rhetoric against China and reached a deal, any deal, the market would rally 5%-10% easily. Job done! if equity markets are the gauge, the problem is easily fixable. Once the uncertainty of trade wars and the impact on demand/supply is removed, markets can go back to their "true" fundamentals and trade normally.
The Fed knows this, and hence does not want to cave in too quickly by pausing rates prior to the March deadline with China. If there is a resolution, all will be sorted and the Fed would have hedged themselves beautifully. If there is no resolution, and this spirals out of control (for the wrong reasons), then they will be able to handle it with a much better footing.
Meanwhile, this is probably the last week of active trading before the disastrous 2018 comes to an end. There are still Hedge Fund redemptions to be carried out in the fourth quarter, mixed with traders throwing in the towel hoping for a year-end rally. Needless to say, the next two weeks will see a lot of volatility and illogical moves, as the dust needs to settle. Best to step away and come back when the coast is clear and P&L is reset back to 0.