On the surface, investors only seem to blame themselves for this whiplash, given the stark contrast between their romance, again, the idea of a Federal Reserve “pivot point” and what, for once, have been consistent messages from the central bank. officials that such a policy change is not in the offing. Below the surface, however, the situation becomes more complicated.
The hope for a Fed pivot early last week was born of three developments. First, Australia’s central bank raised rates less than the consensus forecast; second, the Institute for Supply Management measure of US manufacturing activity was weaker than expected; and third, investors extrapolated from the Bank of England’s emergency market intervention to prevent a potential “meltdown” – to use the word from the deputy governor’s explanatory letter to Parliament – to conclude that financial concerns stability would add to recession concerns as the Fed moves out of what is, at least for now, the most progressive rate hike cycle in recent history.
By the end of the week, all these hopes had been dashed, largely due to consistent statements from several Fed officials as well as a monthly unemployment report widely interpreted as consistent with yet another major rate hike at the next FOMC meeting in early November ( a record for consecutive increases of 75 basis points). It also didn’t help that the OPEC+ decision to cut production by 2 million barrels per day pushed the oil price back above $90 a barrel.
Once again, investors and traders have experienced a terrible trifecta of disappointing returns, disturbing volatility and the positive correlation between risk-free and riskier assets that robs investment portfolios of their ability to mitigate risk by diversifying between stocks and bonds.
In the past, such a “pivot-whipsaw” would normally be the result of some dodgy comment from Fed Chair Jerome Powell suggesting a repeat of his big U-turn in the midst of fourth-quarter market volatility of 2018 – that is, the idea that the long-standing Fed “put” was back in the money.
Not this time. All of the Fed’s speakers, and many of them, reinforced Powell’s latest story that the policy battle against inflation is “unconditional” and that the Fed “would stick to it.” There was no sign of deterioration.
This time, the statement goes beyond inconsistent Fed communications. The following is worth considering.
Perhaps investors don’t need the hint of a Fed signal to get ahead of what they think is a pivot to come. It is enough to look for developments that would force such a pivot, even if they come from abroad. After all, it’s a strategy that reinforced BTD/TINA/FOMO conditioning that was previously incredibly powerful in driving asset prices ever higher (that’s the Buy the Dip if there’s no alternative, especially given the fear of another price to miss) rally).
Perhaps some investors haven’t internalized enough that high and persistent inflation is preventing a credibility-damaged Fed that also relies heavily on data from a preemptive pivot; and that this inflation is accompanied by long-term structural changes. Instead, the world’s most powerful central bank would need strong evidence that core inflation is falling and the broadening of its drivers is being reversed.
The alternative – a pivot caused by a sudden economic or market accident (or both) – is not conducive to buying assets prior to a policy change. It would be a similar situation if inflation fell as the Fed pushed the US economy into a damaging recession.
Last week is not the first time that some market participants have suddenly foreseen an early change in the Fed’s tightening policy. It is noteworthy, however, that they did so without any hint from central bank officials.
I suspect it was years of prior Fed conditioning, along with underappreciation of the underlying structural changes, that made sharp and inherently optimistic investors spring back into what turned out to be another ill-fated – and this time very brief – doom. pivot romance. It reminds us that a conviction without sufficient basis can often be problematic as an investment approach.
More from Bloomberg Opinion:
• Pivot or Godot? Markets Bet Waiting is almost over: John Authers
• BOE must cook monetary porridge just right: Marcus Ashworth
• Gold-plated market issues are not unique to the UK: Richard Cookson
This column does not necessarily reflect the views of the editors or Bloomberg LP and its owners.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is a former chief executive officer of Pimco and president of Queens’ College, Cambridge; chief economic adviser at Allianz SE; and chairman of Gramercy Fund Management. He is the author of ‘The Only Game in Town’.
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