The Fed: Always Late to the Party

In the past few weeks, you have had a wave of Fed speakers give hawkish speeches, chiefly the boss, Jerome Powell.  You would figure that with all this hawkish talk, the Fed would actually consider raising more than 25 bps every 3 months, but central banks have been mostly talk, little action.  

It has been an excruciating rate hiking cycle, starting in 2014 with a Please Hammer, Don't Hurt 'em MC Hammer style slow QE taper, when the US economy was at its post 2008 peak.  The taper should have never happened.  It just delayed the start of rate hikes by over a year, and when the US economy finally started slowing down in late 2015, the Fed reluctantly raised once and froze in the face of a slowdown, with Fed funds stuck at 0.25-0.50%.  

The delay of Fed tightening just allowed more corporate debt to build up and the stock market to reach levels of overvaluation rivaling 2000.  The short term thinking at the Fed, overstaying easy monetary policy and slow to tighten when the economy improves, has resulted in longer, more tepid booms, but also bigger busts.  When stock prices get this overvalued, they eventually lead to a bear market, and that will be the trigger for a recession.  Ever since 2000, the US economy has basically been the stock market.  The stock market is the tail wagging the US economy dog.  There is no real wage growth, so a strong economy won't boost consumption.  It will just make the rich richer, and lead to higher inflation.  That is why there always seem to be a bit of skepticism in regards to the US equity bull market, because it just doesn't match the low growth economy.  

That being said, the current US GDP growth rate is not long term sustainable.  It took a strong US bull market, big tax cuts, with a huge increase in government spending to get to 4% GDP growth.  That isn't happening again next year.  Economy is cyclical, and high PMIs and consumer confidence numbers mean that people and companies are spending now, which makes them likely to spend less in the future.  

Back to the Fed.  They are finally catching up to what the economy has been for the last 18 months.  All this hawkish rhetoric should have been said in the beginning of 2017, not now.  The Fed is already behind the curve.  The Fed funds rate should have been at 3.00% for the last 12 months.  Now they probably can't make it to 3.00% before the SPX has a big correction, which would immediately freeze the rate hikes.  And once they freeze the rate hikes, since the Fed funds is now near neutral, they won't be able to hike anymore.  

That is why you have been seeing the yield curve bear steepening, because the bond market is sniffing out future equity market weakness.  While that can be right in the very short term, beyond the next couple of weeks, I see a flattening.  I don't think the stock market can fall too much because the majority of stock buybacks, nearly 25%, happen in the last 2 months of the year.  That gives the bears about 2 weeks to make their move, and then it will be the bulls taking control with buybacks fueling it.  That should cause the curve to flatten back out in November and December.  Right now is probably the ideal time to put on a 5-30s flattener, at 32 bps, with expectation that it will go back to the level seen in August, around 21 bps.