Heroic Ambitions

The way price has responded (so far) to the September FOMC suggests that while the statement and forward guidance from the Committee was fairly dovish, it was already well telegraphed (and priced) after Jackson Hole. As we noted a few weeks ago, there are no new catalysts to propel risk assets higher, only extrapolation of existing beliefs. There was also very little reaction in rate sensitive markets like bonds, currencies and precious metals (although gold has also come under some pressure now in Asian trade).

From our perch, weakness into the US cash close and in the futures this morning in Asia likely reflects the fact that the Fed did not make any adjustments to the QE purchase program. However, the new forward guidance profile suggests that they won’t move rates off zero until the economy achieves robust growth, full employment and target inflation. The implied hurdle rates appear to be fairly heroic targets based on history.

The new policy framework announced overnight provided a backdrop for what is fairly extraordinary forward guidance. Modification to the mandate was telegraphed at the Jackson Hole meeting in late August, but essentially the FOMC disclosed their aim of pushing inflation “moderately” above 2% “for some time” although there was considerable room for ambiguity or interpretation of these targets. At a high level, this suggests that the Committee will likely maintain the current interest rate until the labor market reaches full employment (an unemployment rate around 4%) and inflation has risen to 2% with room for a moderate overshoot. Those combined targets have only been achieved around 10% of the time since 1960 according to Cam Crise, which suggests that it is a fairly high hurdle rate or ambitious target.

Our sense is that markets also remain concerned about the fiscal impulse or the prospect that CARES 2.0 fails to be implemented due to political grid-lock in the United States. As we have noted before, it is not the size of the budget that matters, but the change in fiscal deficit that contributes to growth. Sustaining the current expansion will likely require continued fiscal easing accommodated by the Federal Reserve. Stated differently, a reversion to austerity or fiscal tightening could derail or undermine momentum in the recovery. The lesson from the decade after the 2008 crisis is that aggressive monetary policy is a necessary but insufficient condition to drive growth. Although the irony is that a reversal in fiscal easing would likely result in additional QE by the Fed. Of course, the downside risk or policy error from the withdrawal of the budget support is so obvious that hopefully it will be avoided.

In conclusion, our tactical bias is that the current phase of weakness in equities is an opportunity to scale up exposure to risk assets. The magnitude of the correction so far (around -8%) has been similar to other drawdown phases through the recovery and the last cycle. That said, a genuine reversal in fiscal support resulting from grid lock in the Congress after the November election might be challenging in the short term for risk assets. What we do know is that the Fed has been very transparent about the path of future short rates and the desire to overshoot their inflation target. However, our sense is that they will be unlikely to attain that goal without the support of fiscal policy. A withdrawal of fiscal support would also likely undermine the potential for a rise in Treasury yields and a rotation from growth equity into value.

About the Author:

Nick Ferres is CIO of Vantage Point Asset Management. Prior to this, Nicholas was at Eastspring Investments, the Asian asset management business of Prudential plc, as Investment Director, in September 2007. Nicholas was Head of the Multi Asset Solutions team and was responsible for managing the global tactical asset allocation of funds for external institutional and retail clients. Before joining Eastspring Investments, Nicholas worked for Goldman Sachs Asset Management as Investment Strategist & Portfolio Manager. He has more than 20 years of financial industry experience. Nicholas holds a B.A. (Hons) in Economic History and Politics from Monash University, Australia, a Graduate Diploma in Economics and a Graduate Diploma in Applied Finance.