Yesterday’s FOMC meeting provided few surprises, yet the market reaction was fairly exciting. I had been expecting Yellen to leave the contentious “considerable time” language in the Fed’s statement. I was hoping for an afternoon stock market rally to short into. Well, I got the rally and now it is just a matter of waiting.
The trading was all over the map, and there were many different cross currents following the statement release and subsequent Yellen press conference.
The stock market behaved as I had been expecting. The FOMC meeting was bullish, and apart from some volatility right after the release, the indexes pushed higher.
The reason the market did not shoot straight up even though the “considerable time” language was left in the statement, was that the infamous dots were raised. For those unfamiliar with Wall Street’s new dot obsession, the Fed has recently introduced a chart with each Fed member’s estimate of future Fed Funds rates. It is supposed to help the markets understand the Fed Governor’s expectations of monetary policy. I think it is dumb because the dots look like Grade 4’s made the predictions.
The dots indicate that for 2015 we have one Fed member who thinks that the Fed Funds will be 2.90% and three who think that it will be under 0.375%. For 2016 the disparity is even more brutal. Three FOMC members think Fed Funds will be almost 4%, while there is one who thinks that we will still be under 0.50% and another two who think we will still be under 2%.
These dots are useless. They assume a degree of forecasting that nobody possesses. Who knows where rates will be in 2017? The jokers at the Fed certainly don’t have any more of a clue than all the other economists.
For the markets to get all bent out of shape because of the movement from meeting to meeting of the dots is Wall Street making a mountain out of a molehill.
We all know the expression watch what they do, not what they say. I think we would all be wise to apply this logic to the Fed as well.
Yellen might mouth some blustering words about the possibility of higher rates, but even in the 5th year of this economic recovery they can’t lift the “considerable time” commitment on their zero interest rate policy.
Yes, the Fed will eventually have to raise rates. But as I have repeatedly stressed, they will only raise rates reluctantly. They will be loath to get out ahead of the curve. The thought that this Federal Reserve is going to get hawkish and try to walk the front end of the yield curve higher is absurd.
Watch what they do, not what they say! And they have done absolutely nothing to make us think that they will be anything except extremely easy.
Now, here is where it gets complicated. If the economy improves, the demand for credit is going to cause rates to rise naturally. At that point, the market will anticipate higher rates, and the Fed will reluctantly follow the curve higher.
If rates go higher, it will not be because the Fed has gotten religion.
This is why I think that the yield curve eventually steepens as the bond market figures out that the Fed is going to leave the front end much lower for longer than their “dot plots” anticipate.
But in the meantime, the market is somewhat buying into the idea that the dot plots mean something. The US dollar in particular interpreted the news most hawkishly.
When Hilsenrath’s article about the likelihood of the “considerable time” language remaining in the Fed statement hit, the US dollar sold off quite hard. When the actual announcement confirmed his prediction, the US dollar rallied. The US dollar chose to interpret the Fed’s statement and subsequent Yellen press conference as more hawkish even though the “considerable time” was untouched.
I think the market is mis-reading this Fed’s willingness to raise rates. Right now I am wrong, but let’s see what it looks like next week. My suspicion is that some of the more serious market players are going to start questioning how much tightening the market is expecting from the Fed.
Scotland – ignore the bankers and politicians – vote for what is in your heart
Today Scotland goes to the polls to decide if they want to remain part of the United Kingdom. Last year, I took the whole family to the UK for a month long summer vacation. Although we spent time in Ireland and England, we spent the longest stretch in Scotland.
I distinctly remember getting into a cab in Edinburgh on the way to the hotel and chatting with my cab driver. Quickly I learned how important it was to him about seceding from England. He was passionate about Scotland controlling its future.
At the time I was surprised to learn that there was even a chance that Scotland was going to leave the UK. Two summers ago it was easy to dismiss him as just a fringe emotional cabby with a nationalistic streak.
But here we are today and the vote is really tight.
I don’t have a prediction on who is going to win.
Canada experienced a very similar situation in 1995 when the Province of Quebec held a referendum on leaving Canada. At the time I was working at Canada’s largest bank as the proprietary equity index trader. Although equity traders are lazy and there was no way we were going to open our markets for trading in the evening, bond traders are much harder working. Our bond desk was to be fully staffed all night – they were prepared to trade their way through the breakup of Canada. Deciding that there would be no better place to watch the action, I asked a buddy of mine on the repo desk if I could sit beside him. So while my co-workers from equity desk were still at the bar, I headed up (albeit with a few drinks in me) to watch Canada break apart. We all know that the vote was close, but with a 50.58% result voting no, the action was quickly anti-climatic. Apart from the long bond trader smashing two phones while I watched, it was actually quite boring.
I am not sure what tonight’s action is going to be like, but I what I wouldn’t give to have a buddy at Royal Bank of Scotland right now…
When Quebec was threatening to leave, I joked that the rest of Canada should have a referendum on whether they should be allowed to stay. I was embarrassed when the rest of Canada rallied, begging Quebec to stay. I felt that Canada is a great place and that if Quebec didn’t want to be a part of it, then that was fine with me. Like the terrible boyfriend/girlfriend that is always threatening to leave, the rest of Canada needed to stop being held hostage to threats of Quebec separation.
If the Scots want to separate from the UK, then they should not be influenced by the shrill cries from the doomsdayers predicting financial armageddon. The markets will sell off, but it will not be a cataclysmic event by any means.
Assuming that everyone negotiates the break up in good faith, then an independent Scotland will simply be a reorganization of the balance sheet. There will be very little actual wealth destroyed. Contrast that to Ukraine where the breakup of their country is resulting in fighting, destruction of buildings and factories, and a general inability for the public to live their lives. There is a very real loss of capital.
There are many pundits forecasting dire consequences if Scotland votes YES. Even my favourite trader George Soros wrote an Op-Ed about how this was the worst possible time for Scotland to break from Britain:
Divorce is always messy. A vote for Scottish independence would weaken – in political and economic terms – both a truncated UK and Scotland. An independent Scotland would be financially unstable, especially if threats to renege on debt repayments were carried through.
Although I love the codgy old bugger, George is talking his book on this one. If Scotland leaves the UK it will most likely be fine. But it will cause a lot of problems for the EU. Their political union is being held together by a shoe string. An independent Scotland will only encourage an independent Catalonia, or any other host of EU member countries that are being suppressed by Germany’s reluctant tight money policies. George is most likely long a bunch of periphery EU countries and a destabilization of Europe would be the last thing he needs.
Many of the warnings about Scotland leaving the UK reflect the worries about the tenuous political unions in the rest of the world as opposed to problems with Scotland leaving the UK.
I hope that the Scots ignore these warnings and simply vote for what they believe.
If they want to have independence, then by all means they should go for it. Ignore the bankers’ and politicians’ worrisome predictions. It will be fine. Soros says that divorce is always messy. I guess he should know as he has gone through three of them. But divorces don’t have to be. If everyone behaves like adults, there is no reason that there has to be problems. And in fact, often the two parties find that they can be even happier just being “friends.”
If Scotland does vote to secede, and UK markets get hit hard, then I will be looking to be a buyer into that weakness. I don’t think there will be any rush, but I would be looking to fade any real panic.
A couple of energy names to think about
Although I might outright buy Pounds or FTSE if we get a serious break, I am also watching two of my oil stocks closely.
Talisman Energy has been suffering from their exposure to the North Sea. Icahn and some other activists own the name, and it is likely that this company will get sold, but with the Scottish vote looming, I think the process was put on hold. If we get a NO vote, then I will think about picking some it up.
Also, my favourite little energy stock Ithaca Energy has being trading like the grim reaper has a big position. I think that a lifting of the uncertainty from the Sottish referendum will help this stock as well.
If the vote is YES, I will watch these two names for weakness. I won’t rush to buy them because I suspect it will be a long process before they turn back up, but if they get stupid, I will be there to catch them.