Barron’s always-insightful Randy Forsyth exposes the ugly reality that this is a “Bullard” market and we are just living in it as the flip-flopping Fed head is “the most visible telltale of the shifting winds of Fed expectations. Investors navigating the choppy waters of the financial markets are forced to change tacks accordingly.”
Only one thing matters..
Micro-economy? Earnings expectations… Nope!
Excerpted from Barron’s – Is it a bull market or a bear market? Or maybe just a Bullard market?
That is, as in James Bullard, the president of the Federal Reserve Bank of St. Louis. Not only is he among the voters this year on the policy setting Federal Open Market Committee, he is also perhaps the most vocal member of the panel’s adjunct, the Federal Open Mouth Committee.
In his habit of speaking early and often, Bullard has developed a nearly unequaled ability to move markets, which was on display last week. In various appearances, he suggested that the central bank’s next interest-rate increase could come as soon as the FOMC’s meeting on April 26 and 27.
Bullard’s point last week was that the conditions that let the FOMC make its long-awaited initial increase in its short-term interest-rate target in December — to 0.25%-0.5%, 25 basis points (a quarter-percentage point) above the near-zero level where it had been held for seven years since the dark days of the financial crisis — were present. That is, unemployment had met the Fed’s target, at just under 5%, while inflation was closing in on the central bank’s goal of 2%.
But that was far different from what the St. Louis Fed chief was saying just last month
- On Feb. 17, he contended in a speech that it would be “unwise to continue a normalization strategy” — read, rate hikes — while inflation expectations were declining.
- So, in five weeks, Bullard has gone from arguing to hold off on higher interest rates, as the FOMC opted to do at the March 15 and 16 meeting, to putting them on the table as soon as next month.
What has changed so radically in that span?
The market-based measure of inflation forecasts did advance. According to the St. Louis Fed’s own charting, five-year forward inflation expectations ( derived from the spread on Treasury inflation protected securities, or TIPS, versus regular Treasury notes) did tick up to 172 basis points on Wednesday, when Bullard made his comments to the New York Association for Business Economics. They had been at 152 basis points on Feb. 17, when he cautioned against rate hikes.
That’s a mere 20-basis-point uptick over that span, and 30 basis points from the low touched on Feb. 11. Arguably, what has really changed since then has been the stock market, which rallied sharply, with the Standard & Poor’s 500 index jumping more than 12% above its February low to last week’s peak. After Bullard made his comments on Wednesday, stocks retreated in tandem with a renewed slide in crude-oil prices and a pop in the dollar, ending their five-week winning streak.
In that period, the world’s central banks all got on board with accommodative policies: Interest rates plumbed deeper into negative territory, the European Central Bank expanded its stimulus, and the Fed stepped back from its previous timetable of four rate hikes in 2016. The last suggestion helped spur the 11% correction from the end of 2015 through February, amid the ongoing slide in oil, a toxic deflationary combination.
This was far from Bullard’s first market-moving flip-flop. In October 2014, as stocks were sliding ahead of the well-advertised end of the Fed’s quantitative-easing program, Bullard suggested that the central bank could continue its bond purchases, again citing too-low inflation expectations. On the date of those comments, Oct. 16, the S&P 500 made its lows, and went on to rally some 14% to its peak last May.
The circumstantial evidence also suggests that Bullard’s comments coincided with swings in stocks as much as inflation expectations. With the S&P 500 having mostly corrected its early-year correction, if you will, and the index solidly north of 2000, the St. Louis Fed head adopted a hawkish tone. But he was distinctly dovish when the S&P 500 was in retreat in the low 1800s, most recently in February and previously in October 2014.
This doesn’t suggest that the Fed is explicitly targeting the stock market. The causality arguably runs in the other direction. Expectations of more rate hikes result in a stronger dollar; weaker prices for crude oil and other commodities; a flatter yield curve — all disinflationary indicators — and retreats in risk assets, such as high-yield bonds and equities. When rate-increase expectations subside, those markets reverse.
At this point, the federal-funds futures market is definitively pricing in only one 25-basis-point hike this year, with odds of 60% by September and 73% by December, according to Bloomberg. For April, when Bullard thinks an increase should be considered, the futures market’s probability is just 6%. Those low odds seem justified by persistently tepid gross-domestic-product growth. The GDPNow tracking model from the Atlanta Fed was lowered last week to a real annual rate of just 1.4%, about half the estimate in early February, and no better than the revised final fourth-quarter GDP report released on Friday.
Bullard seems to be the most visible telltale of the shifting winds of Fed expectations. Investors navigating the choppy waters of the financial markets are forced to change tacks accordingly.