Wall Street, or at least its public face – the mainstream financial media, is obsessed with the notion of a “Fed pivot”. It has been almost the sole mover of stock prices for months. The first half selloff was driven mostly by the growing realization that the Fed was going to hike rates. The midsummer rally was driven by anticipation the Fed might dial them back sooner rather than later. The ensuing selloff was prompted by pushback from the Fed, with everyone from Powell on down effectively saying no, we’re serious about this.
A sharp early October rally was again, driven by anticipation of the same pivot grail. Then it was squashed again by the Fed yet again underscoring its not-so-fast message.
But we’re not here to feed this insanity, we’re here to show just how irrational it is. The entire sooner-pivot-versus-later-pivot narrative is built on false premises.
Number 1 among them is that a halt in Fed rate hiking – and its opening of the door to rate cutting – will propel stock prices upward. History tells us otherwise. Rate cuts do often lead to rising stock prices, but the timing is far from assured. The 2008 bear market stands as testament to the falsity of this premise. Stocks experienced a vicious bear market in which prices were more than cut in half. Then the Fed stopped hiking rates, pivoted to cuts, and a new bull market was born.
Except that isn’t how it happened. The Fed cut rates the whole way down. In fact, the first rate cut came before stock prices even topped, let alone bottomed. The first cut of the 2008 bear market came in September 2007. Stocks peaked in October 2007. The Fed also cut rates for much of the preceding bear market in 2000-2002 as well.
In short, any rally predicated on a future Fed pivot from tightening to loosening is not only getting ahead of Fed policy, but waaay ahead … by virtue of not even being correct in its assumption that such a policy pivot would be accompanied by a market pivot. The words of George Soros’s famous dictum, ring out … “… the trend whose premise is false …”
Another Soros formulation applies as well, and that is his notion of “reflexivity”. All markets are really just interconnected parts of one overall market, and what happens in one affects the others. One cannot just draw an arrow of causality from Fed policy to stock prices. It works both ways. The Fed has told markets time and again this year that it sees “financial conditions” as a transmission channel from policy to the economy. It happens to be right in its own twisted way, but that doesn’t even matter. What matters is that higher stock prices in the Fed’s eyes mean looser financial conditions and call for more policy tightening … so higher stock prices mean higher policy rates. So there is no realistic scenario in which stock prices can sustainably rally ahead of any Fed pivot; that would simply push any such pivot further into the future. For stocks, at these prices, there’s no winning scenario. The Fed call is still in effect, and the Fed put has a strike price well below today’s levels.
8 thoughts on “The Fed Pivot Fallacy”
I think the pivot narrative is entirely based on the events of 2018-2019.
and it’s hard to believe we’ve reached a bottom when so many are looking for the bottom as a signal to buy. the real bottom will evoke nausea at the thought of buying stock.
No scenario is ever exactly like an earlier one, but between 2008 & 2018 the former wins hands down. We had an obvious inflation problem in 2008, we didn’t in 2018.
In fairness there are also some differences with 2008 … we also had an obvious point of failure with subprime, although even that was infamously an object of denial. That doesn’t carry a lot of weight though because failures can seemingly emerge from nowhere, like LTCM ten years earlier. The more significant difference with 2008 is that then the Fed was easing, now it’s tightening. But that’s just the point … the markets’ obsession with Fed timing is egregiously misplaced. In the scheme of things, 2018 is more the exception than the rule.
Traders may have the even more recent 2020 event in mind; but the pandemic related shutdowns make it such a joker in the deck it’s not even worth discussing.
This highlights another cost Powell et al incurred when it buckled in 2018. Credibility. The markets don’t believe what they say. They now have to tighten more than they otherwise would have to compensate.
When I listened to Alex Gurevich’s recent interview on the MacroVoices podcast, all I could think about was your Synthetic Systems forecast. He provides the fundamental narrative for your strong bond market forecast.
Here’s the transcript:
Thanks KBird. I’ve cited fundamental reasoning for this on a couple of occasions in comments, for instance in
FWIW, I always look for a fundamental case when assessing Synthetic Systems forecasts. It’s never enough by itself to justify any major weighting departures.
That said, usually SS calls a trend long before the fundamentals become apparent. In 2017 it called for commodities to rally in 2020-2021. It began to forecast the same bond rally it does now at the beginning of 2021. So I look to it for advance planning, then watch for confirmation from the fundamentals. At the same time, fundamentals generally are better at identifying what should happen than when, so SS pitches in there as well. Final confirmation comes when the market actually turns.
The date SS has been targeting for several quarters (with the exception of last quarter) was October 1, so we’re now into the projected time frame. A good fundamental case is present. The final ingredient however is still not apparent – a catalyst. About what that catalyst would be we can only speculate … my guess is some financial accident or geopolitical development occurs that sends stocks rapidly downward, satisfying the Fed’s quest for tighter financial conditions, leading to a strong rally in bond prices. It would have to be significant enough that stock prices don’t rise with bond prices … a classic “risk-off” process. Or SS is wrong.
In short, the Fed does ultimately pivot, but stocks have to come down first.
Another excellent piece of fundamental analysis from Michael Lebowitz at RIA:
Goodbye TINA – Hello BAAA
I think the stock market is done here.
When the BoE intervened the other day to buy gilts I think it was taken as a message that the Central Bank Put was still in place in Western markets.
However the BoE have come out and said
” the Bank of England would not extend its emergency intervention in financial markets beyond this week, after the turmoil sparked by the government’s mini budget.” I don’t think many expected that. The IMF have also been weighing in on the UK Government’s and BoE contradictory policies.
The powers that be have decided that the punch bowl is to be removed. Reality is about to set in.
After years of spiking the punch bowl, it It is a wonder to witness central bankers queuing up for the twelve step program. So far not even the pleas of the financial industry for a hair of the dog remedy have been enough to tempt them out of line.