Fed's Pivot

Macro Perspectives: Tue 10 Aug 2021

Let's talk about the recent pivot from the Fed that continues to transform the theme for markets.

We entered the year with a clearly telegraphed, massive fiscal spending agenda - and with a Fed, happy to keep the pedal-to-the-metal on monetary policy for the foreseeable future (until at least 2023). We are now eight months in, and the fiscal spending agenda is fully materialising. Yet suddenly, the tune the Fed has been singing has changed.

It started with Powell's late July (post-FOMC) press conference, and continued with a well placed comment from the Fed Vice-Chair following last Wednesday's weak ADP number.

Remember, in late July, with nearly $4.5 trillion lined up for approval on Capitol Hill, all advanced under the cover of the Fed's drumbeat that inflation is “transitory,” the Fed, conveniently, decided it’s time to explain its nuanced definition of transitory.

We heard for many months how the deflationary trend of nearly four decades just "doesn't change on a dime" (in the words of Jay Powell). Therefore, the drumbeat has been that short-term inflation is simply a product of "bottlenecks" and "base effects." Don't worry, when these supply chain disruption-related bottlenecks work out, "inflation is expected to drop back down to our longer-run goal," we were told.

Now, in the span of two weeks, the Fed has told us that, sure, prices have soared, but transitory means they just won't continue soaring at the same rate. Slower rate-of-change, after what is tracking to be double-digit annual inflation, still means we've all been hit with a massive inflation. It’s forcing wages higher, which is a driver for higher inflation rates.

Bottom line, the Fed has been doing what they do. They've tried to manipulate expectations on inflation through their "guidance." That doesn't necessarily have anything to do with reality. When it's time to move, they move and it appears that they will be tapering into the end of the year - the Fed chatter has started about moving on rates next year.

So, the Fed has pivoted. Market interest rates are going up.

What does this represent for the global economy? Does it represent the end of the pandemic and economic crisis? On the latter, a change in the direction of the interest rate path in the United States, especially leading the way out of a global economic crisis, will only draw capital out of global economies and into the U.S. (in search of yield and relative growth and safety).

That especially won't bode well for emerging markets. We've seen the movie before, following the great financial crisis.  Capital flees. With that, if you've enjoyed the rewards of this chart, it's probably time to sell.