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Fight the Fed, not the bond market

by Ashraf Laidi

As today’s release of the minutes from the 16th-17th December meeting further boosts equity to new intraday highs, the question becomes whether we should worry that the stock market rallies are especially reinforced during Fed-driven events.

Remember, the 17th December announcement triggered a 40-point rally in the S&P500 - the biggest percentage gain since October 2013 – as a result of an unexpectedly dovish FOMC statement. More specifically, the statement sounded more dovish than Fed chair Yellen did at her post-meeting press conference, when she indicated rates could be raised after a “couple” of meetings, leaving some to conclude that rates could be hiked as early as April. That last phrase fired up the US dollar on all cylinders without diluting any of the explosive rally in stocks.

Important reminder to rate hike believers

Those convinced by the inevitability of a 2015 rate hike ought to be reminded by the Fed’s more forceful emphasis on low inflation at the December statement, stating it will “monitor inflation developments closely”, which suggests this is now the Fed’s top priority.

In our view, the emphasis offset the Fed’s visible upgrade of labour market conditions. The Fed also grew more dovish with regards to its softer forecasts on its views for 2015 inflation and fed funds.

The minutes appeared to state the obvious by indicating that the use of the “patient” guidance meant no rate hike in the “next couple of meetings”, quashing speculation that a move could happen at or before the April meeting.

While the majority of market observers appear to agree on June 2015 as the most likely date for a Fed move, not only we disagree with such forecast, but continue to not see a Fed hike in 2015. The reasons are described in more detail in our deflation assessment here.

You can fight the Fed, but not the bond market

The old market cliché of ‘don’t fight the Fed’ remains valid in highlighting the Fed’s authority to limit violent market instability and prolonged recessions, but do not confuse it with Fed members’ hints of rate-hike intentions, especially at a time of rampant lack of visibility by Fed researchers with regards to the new equilibrium rate of unemployment at a time of flashing deflationary pressures.

The bond market chart below reminds that the bull market in bonds (bear market in yields) has never left us, and a retest of 1.38% in 10-year yields is upon us. Any bounce above 2.45% would be reversed and the next Fed hike signal would be promptly received by falling yields as growth concerns – not inflation – take over.

After all, our yields bearishness was intact back in August, with this chart.

SPX-Fed-policies-Oct-29

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