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Albert Edwards: is pussycat Fed set to morph into a leopard?

Albert Edwards: is pussycat Fed set to morph into a leopard?

Albert Edwards has been waiting for this moment for a while. 

However, SocGen's strategist does not believe the Federal Reserve's hike in rates last night marks a significant change in tack from the central bank. 

'So finally the Fed has got its ‘a’ into ‘g’ and raised rates' Edwards told investors in his latest note.

'Although this will be the first of many rate rises in a move to normalise rates, the Fed’s lack of verbal assertiveness means the market still cannot bring itself to believe the Fed’s own projections for interest rate hikes.' 

Edwards draws on comments made by his colleague Kit Juckes to sum up his own feelings. 

Juckes said: 'The Fed's reluctance to send an aggressive tightening signal, instead preferring to again shuffle upwards its dots just slightly, has disappointed markets.

'But to be fair, the problem isn't really with the famous dots. It's with the market, which just doesn't believe the Fed will tighten as fast as they say they plan to (see chart below).

'If the market took the Federal Open Market Committee (FOMC) at their word and discounted a 3% Fed Funds rate at the end of 2019 and beyond, then we'd probably have a 3% nominal 10-year Treasury yield by now.' 

Edwards questioned whether the dovish Fed can ever really change its spots. 

He refers to Juckes analysis again: 'After spending the 1980s defeating inflation, the Fed has allowed rates to spend progressively longer and longer below the nominal growth rate of the economy (see chart below).

'Trend nominal growth is only a first estimate of where the natural rate
of interest might be and it’s definitely been dragged lower than that in recent years –but depressed market volatility, and the strength of asset prices [are] a result of low rates.' 

'And nominal GDP growth is at 3.5% while the FOMC’s range for the dots in 2019 was 3% wide, from 0.9% to 3.9% with a median at 2.9%.'

Ultimately it is the reluctance to damage stockmarkets which will prevent the Fed from escalating the pace of rate hikes, according to Edwards. 

'One reason why the market doesn'’t believe the Fed dots is that investors cannot conceive of Fed tightening to the point that it causes the stockmarket any serious damage,' Edwards concluded. 

'Time and time again over both this and previous cycles the Fed has backed off rate hikes as soon as the going got tough.

'Maybe that is why the S&P trades at such a huge PE premium to the rest of the world’s equity markets (see chart above), for only a small part of this divergence can be attributed to sector composition.' 

 

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