Hawkish & Bullish

Macro Perspectives: Tue 02 Nov 21

We'll hear from the Fed tomorrow - expected to start dialing down their monthly bond buying program (QE).

The market is now pricing in about a coin-flips chance that they will start the lift-off of interest rates in June. That's a more aggressive timeline on the first rate hike than the Fed projected in their last meeting. We should get clues on if, and how many, rate hikes might come next year, by the way they telegraph the cuts to their bond buying program.

If the history of the post-financial crisis era is a guide, they will probably map out equal cuts to their current $120 billion purchases each month (currently $80 billion of Treasuries and $40 billion of Mortgage-Backed Securities). A cut of $15 billion a month could get them to the end of QE by June of 2022 - and ready to begin raising rates.

The market would, of course, consider that timeline hawkish. 

Hawkish, in normal times, would be bad for stocks (and the risk environment). But given the likelihood that the Fed is already behind on managing an inflation problem, hawkish should be translated as a positive for markets.

With the potential for visibility on rate hikes coming this week, the stocks that tend to move with rising rates (tracking an economic recovery) finally started moving - the Russell 2000 (small caps) led the day, up 2.6%. As you can see in this chart, small caps are just now closing in on the highs of the year (which was a record high), set back in March.

Conversely, the S&P 500 is now sixteen percentage points higher than its March (record) highs.

Remember, historically, small caps outperform large caps coming out of recession - as they tend to track interest rates higher in the economic recovery. I expect small caps to close this recent performance gap with the S&P 500 - and maybe quickly.