Why Stocks Keep Rising Despite Another Rate Hike On The Horizon: One Explanation
By Tyler Durden
With Janet Yellen due to speak in under an hour (in a speech that will be a big dud because as SocGen notes, “little emphasis on the monetary policy outlook is expected at this event”), a recurring question is why does the market remain so nonchalant about the possibility of a rate hike as soon as one month from now.
One of the better explanations on the matter comes from Citi’s Steven Englander, according to whom it boils down to the market’s sentiment about what happens with the Fed’s hiking path after the first hike. As the Citi strategist points out, this is merely the latest feedback loop the Fed has found itself trapped in:
Asset markets have done very well since the fed funds market began pricing in a summer hike. The question is why? We think that investors are trading the equation
an extra 2016 hike but very little else + better Q2 growth data = stronger asset markets
The question is whether this is a sustainable equation. Better growth, if sustained, is likely to induce more hikes. If we go from ~2.5% GDP in Q2 to 1.5-2% subsequently, we are likely to unwind the recent optimism.
Or maybe we won’t, because the only thing more bullish than a hawkish Fed is a dovish Fed. Let’s assume for the sake of this argument that the market is, like it was in December, fixated on the favorable “growth” outcome as a result of an upcoming rate hike (something with Jeff Gundlach mocked two days ago), as the alternative of yet another Fed policy error may be just too much of a shock. Here is why Eglander is cautious in reading this interpretation:
On the better sustained growth/faster hiking scenario, the slope of the Fed’s policy rate path will steepen. This will be another challenge to commodity and EM currencies. It may well turn out that a modestly steeper path of Fed hikes does not damage global growth prospects or asset prices a lot, but that is not likely to be the immediate response.
Alternatively if the hiking path reflects the expectation that better growth is temporary, the recent strength of US asset markets may come into question. The shallow path of hikes now priced in will not take the Fed away from the danger zone of a negative shock pushing them into the incipient negative policy rate. So a resumption of 1-2% growth rates after a solid Q2 may sap the confidence that markets have displayed in recent weeks.
In other words, the market is confident that the Fed’s rate hike itself will be enough to stop any more rate hikes, irrelevant of the data. What the market is forgetting however is that the rate hikes in early 2016 were delayed not so much because of the data, which was already deteriorating as the Fed hiked, but because of the market’s reaction. As such, the “market” is hoping to skip the critical step where it sells off to …read more
Source: Why Stocks Keep Rising Despite Another Rate Hike On The Horizon: One Explanation
