Fed pulls the old bait and switch and investors are left kicking air

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Well, the United States Federal Reserve on Wednesday did two pivots separated an hour apart. The central bank tells us it is mindful of the policy lags, but even with that, it intends (for now) to take the funds rate above the median dot-plot terminal rate forecast of 4.6 per cent that it published at the prior September meeting.

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That was the moment that everything got undone, from the stock market to the yield on the two-year T-note. Incredibly, from the post-statement high in the S&P 500 to the close after the bombshell during the Q&A, the S&P 500 plunged 134 points, or 3.4 per cent, and the Dow Jones industrial average swung lower by 910 points (in barely more than an hour), or 2.8 per cent.

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But I tell you what: I will no longer do a writeup on the Fed just based on the press statement. Given that this is not the first time the statement gave a head fake as chair Jerome Powell delivered a different message at the lectern, it pays to wait.

He is Lucy, and the rest of us are Charlie Brown. Who knew that mentioning for the first time that the Fed is cognizant of the policy lags, that it was more of a throwaway statement than something with true policy implications, outside of going slower than these aggressive hikes of 75 basis points and merely going 50 basis points or 25 basis points until it sees a multi-month string of extremely weak inflation readings?

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It is incredible that Powell could tell us he knows how the dominant rental component in the consumer price indicator is constructed and how it is destined to lag what is happening to inflation in real time. It is equally incredible that he dismissed his favourite yield curve in a question from Bloomberg reporter Mike McKee, who reminded the chair that when it was steep six months ago, the view was “no problem” until it inverts.

Back then, Powell intimated that an inversion would signal the need for the Fed to begin thinking of easing policy. The spread between three-month rates and the 18-month forward expectation of the three-month rate touched two basis points in recent days, and is well off the nearby highs of 130 basis points, and the best the chair could say was “it’s not inverted.”

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As for saying that the policy lags are long in nature, Powell started off by stating how weak the economy has become with flat growth so far this year … and that means that the lags are already kicking in. This only leads to one thing: the Fed wants to continue to take the punch bowl away.

Perhaps the press statement was a test for everyone, especially the bulls. As the Fed saw the stock market surge, that gave it all the incentive to lower the boom. I sense that not until the market fails to respond positively to any sign of a pause, until the perception that there is a Powell Put is extinguished, the Fed will just keep on going.

The risk to the stock market with this information is obvious and it is bearish. Yesterday was a real lesson — see how the market responds to the smallest shift in tone, and the Fed did not like what it saw — it was basically mid-June to mid-August lumped into an hour. Remember that economist Neel Kashkari after Jackson Hole said something to the effect that the central bank does not want the stock market to go up. Enough said. “Don’t fight the Fed” works in both directions.

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As for the policy lags, we don’t have to wait. Right off the bat, here is what Powell had to say on the macro scene:

“The U.S. economy has slowed significantly from last year’s rapid pace. Real GDP rose at a pace of 2.6 per cent last quarter but is unchanged so far this year. Recent indicators point to modest growth of spending and production this quarter. Growth in consumer spending has slowed from last year’s rapid pace, in part reflecting lower real disposable income and tighter financial conditions. Activity in the housing sector has weakened significantly, largely reflecting higher mortgage rates. Higher interest rates and slower output growth also appear to be weighing on business fixed investment.”

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The Fed is still keen to hammer the economy and risk assets and tighten into a flat or inverted yield curve, and we haven’t yet seen all the bad stuff hit the wall just yet. He knows the economy is weak. He knows inflation is a lagging indicator. He was mixed on wages, too. He knows about the yield curve. It’s all about continuing to take the punch bowl away.

The inflation he really wants to destroy is in assets — equities and real estate. Back to the 2018 Powell, but this time he has Joe Biden giving him the nod instead of Donald Trump getting in his way.

David Rosenberg is founder of independent research firm Rosenberg Research & Associates Inc. You can sign up for a free, one-month trial on Rosenberg’s website.