Dear All,

Some takeaways following yesterday’s decision by the Fed.

  1. The ‘exit logic’ has been in force since the taper tantrum of 2013
    First of all market participants had already been in a tightening mode since the taper tantrum occurred in May 2013. By considering the 2Y Treasury Yield, the trend has never really been broken since then. At the current level of 0.68%, notwithstanding an impressive 13bp drop yesterday night, short term rates remain at the top end of the range.
  2. Growth weakness: no reason to worry, yet important enough to mention
    Strange message delivered by the Fed yesterday. It seems clear that it cares about the recent turmoil in China. It is less clear however if it considers these developments as merely transitory or more resilient. As the article attached mentions – the title is excellent! – a link surfaced between the rest of the world and the decision function of the Fed. In other words, even if the statement looks reassuring, these forces are strong enough to influence the most powerful central bank of the world. “Read my lips”…
  3. Flows, flows, flows
    As the paper of El-Erian attached comments, it is highly probable that the massive capital flows out of global emerging markets have weighed on the Fed’s decision function. This point deserves real attention: quantitative tightening (as some name it) plays a de facto tightening role on the US economy as well.
  4. Volatility strikes back
    The Fed may have a clear view on points 2 and 3. Or maybe not …
    The point is: a status quo extends the uncertainty and volatility regime that was prevailing prior to the decision. Back to point 1: in an ‘exit environment’, any additional support comes at a certain cost. At this stage, my best assumption would be that the Fed is not able to maintain its ‘Greenspan put’ any longer. An assumption that seems to be supported by the ‘resync’ between the markets and their fundamentals. Please turn to the next point.
  5. The “resync” is confirmed
    One of the important development underneath the Chinese turmoil was the resync between market valuations and their fundamentals. By integrating the turmoil in its decision and comments, the Fed has, maybe, confirmed and even strengthened this repolarization.

So, let’s sum up:

– 2 : growth is at risk,
– 4 : no free hedge by the Fed any longer,
– 3,1 : quantitative tightening is here to stay,
– and 5 : the ‘resync’ is confirmed.

Maybe then the markets have very good reasons to correct … sharply.

Have a good week-end,
Jacques

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