Wall St Soars – What happened?

Last night Wall St soared with the Dow up over 600 points (2.5%), the S&P500 similarly up 2.3% and the besieged NASDAQ up 2.95%.  Those are big numbers in shares.  The Dow wiped out all of its losses for this month and is now back into positive territory for 2018, so what happened? The Fed happened.

Arguably some of the reason for the turmoil of late on Wall St is the threat of the US Fed continuing to raise rates into a market priced on cheap credit.  To date (and as recently as last month) the Fed chairman, Jerome Powell, has talked of the Fed considering US interest rates being a “long way” from “neutral”.  That implied many more rates rises to come which spooked a market carrying record amounts of debt.

Neutral means that goldilocks state of their policy neither speeding up nor slowing down economic growth.  Remember the Fed (as is our own RBA) is principally charged with keeping the economy healthy whilst avoiding it overheating and leading to a recession by keeping unemployment low and prices stable (ala inflation at 2%).  In theory they are not guided by the relatively short term gyrations of overvalued sharemarkets.

The Fed is supposed to be independent, something the current President is testing with constant expressions of disgust with their tightening policy unravelling his bull sharemarket.  Trump believes the Fed is making an error in the source of their decision making….

“I’m not happy with the Fed…..They’re making a mistake because I have a gut and my gut tells me more sometimes than anybody else’s brain can ever tell me.”

The big jumps yesterday were off the back of Powell changing his language from their being a “long way” from neutral to “slightly below” neutral.  The market read that as the (almost certain) December hike being the last for some time.  His live comments came on the same day the Fed released a report warning of multiple challenges 

“An escalation in trade tensions, geopolitical uncertainty, or other adverse shocks could lead to a decline in investor appetite for risks in general……The resulting drop in asset prices might be particularly large, given that valuations appear elevated relative to historical levels.”

To stop hiking in December would leave the US cash rate at 2.5% after a 0.25% rise in December, leaving little room to ease when, not if, the next recession arrives.  As Jim Rickards tweeted last night:

“the idea that the Fed will stop rate hikes at "neutral" is absurd. That was never the goal. They have to get to 3.5% or higher to prep for next recession. The hikes will continue.”

Countering that is how the market handles the interest cost should that happen.  At 3% the US starts looking at $1 trillion in interest on Federal debt.  And on that corporate debt burden we’ve been warning about, Powell last night warned:

"Information on individual firms reveals that, over the past year, firms with high leverage and interest burdens have been increasing their debt loads the most"

Debate now rages amongst analysts about what this means for hikes next year.  Whilst many are reading the change in language as meaning few if any, Societe Generale’s Omar Sharif thinks Powell was just correcting a “rookie error” of being too aggressive/loose with his “long way” comment and that we shouldn’t read too much into it.  He notes the paradox few seem to be ‘getting’:

"Either market participants are anticipating a sharp deterioration in growth that brings GDP below potential (recall that the Fed has 2.5% next year versus 3.1% this year), or a sharp slowdown in inflation, or they think something will "break,"

Not surprisingly then, gold rose as well on the news.  Playing the fickle market whilst keeping your hedge in play….