“Don’t fight the Fed” is a phrase or a casual policy of sorts that tells investors to align their investing strategy with the current monetary policies of the Federal Reserve System (the Fed) — rather than against them. And yet — last 2 trading days, we found the market fighting with the Fed to regain control of monetary policy!
Jerome Powell, Chairman of the Federal Reserve spoke yesterday and said that we should expect to see one-time’ish surge in short-term inflation sometime this summer (post vaccine rollout and return to normal economic activity.) He added somewhat awkwardly that he wasn’t worried about it though — it being … INFLATION. His rationale: he thinks that the summer inflation spike would just be in the short-term and just be a one-time thing.
I personally think that if he COULD openly say what he truly feels, the tape would read something like this … I know how worried investors of risk assets as well as people living off of fixed incomes or pensions are going to start getting as this summer approaches (i.e. NOW) and I’m kinda sorta with them and I too am worried about the stock market overheating and people losing purchasing power in their day-to-day lives.
He/the Fed would probably really really appreciate the private side of the market to provide liquidity in the credit or bond markets. We all get this feeling that the Fed is getting a little fed up being the sole liquidity master. First, it was the pandemic and then the market crash of early 2020, and now the Fed is staring at a steepening yield curve — almost trying to stare it down into submission or flatten. Wow — what a staring contest. Just like we used to play as kids … ‘Don’t Blink!’
Powell’s narrative yesterday sets the stage for the next Fed meeting on March 16th. We will have to wait and see what they decide to do or not do then…
If long bonds (long duration Treasuries, to be specific) keep calling the Fed’s don’t-blink bluff, then the Fed would probably have to start selling its short-dated bonds (which makes their prices to fall, and therefore, their yields to rise) just to turn around and buy longer-dated Treasuries (which would make their prices rice and yields fall) to flatten the yield curve. Why?
- Well, you can see that the interest rate on the longer-end of the yield curve (the rates that banks use to lend on) are steadily hiking up. Whereas, the ultra-short rate is staying low and this is where banks are borrowing at. Banks are basically borrowing for cheap and loaning at a big premium. This is called a steepening yield curve, which is good for banks and financial companies!
- But … inflation and rising long-term interest rates are not good for high-growth companies, tech stocks, or for the housing and mortgage market! And, we all know that when tech and housing has a little melt-down of some of its recent melt-up, the market and people start to panic and we see corrections like we have seen last 2 trading days — pretty much across all asset classes — even Blockchain and Bitcoin weren’t spared.
So, now what?
— Watch closely how correlation changes between different asset classes! This is going to be key moving forward.
— Watch closely what the Fed says and does at the next meeting. Who is going to blink first??
— Search high and low for strong inflation hedges. You just may be forced to pay close attention to Blockchain and Cryptocurrency assets and their relationship to other risk assets-after all!
Blog by Payel Farasat, MScFA (CIO, Burkhan World Investments)
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