Stocks rise after Fed walks fine line on tapering, rate hikes

European markets trading higher after the Fed delivered another lesson in how to gently massage markets into accepting that tightening is on its way. The FTSE 100 has recovered all its losses this week, back to the 7,100 area. Wall Street rallied on the Fed’s apparent lack of haste to taper, and didn’t worry that policymakers see rates lifting off sooner than previously indicated. The S&P 500, Nasdaq and Dow Jones all rose 1%, whilst small caps rallied 1.5%. Benchmark 10yrTreasury yields initially softened on the release but have since recovered to around 1.34%. Gold initially rallied but has since pulled back. The dollar fell at first but after a brief rally to its highest since Aug 20th is back to where it was before the statement.

More liquidity from the PBOC eased worries, Evergrande shares rallied 17% in Hong Kong, where the broad index rose 1%. The Bank of England later today will be the main focus for markets, particularly UK assets. The Old Lady will need to respond to the biggest jump in inflation on record and worries that it could lose credibility if it allows longer-term inflation expectations to slip their anchors. UK 1-yr inflation expectations shot up to 4.1% in September from 3.1% in August, according to the Citi survey, which also showed longer-term inflation expectations drifting higher. Although well into a taper of its own, the BoE would be well justified in ending QE today.

The Federal Reserve gave the market plenty to think about but didn’t cause a tantrum. Jay Powell continues to walk the line between guiding the market to expect tightening without unduly worrying investors. The overall feeling was giving with one hand and taking with the other; for instance, inflation was revised higher but unemployment and growth moderating. The Fed is hedging its bets a bit but overall it’s leaning in towards tightening – the question is whether it starts to lean in more as inflation sticks.

Key takeaways:

• Tapering coming soon: “Participants generally viewed that so long as the recovery remains on track, a gradual tapering process that concludes around the middle of next year is likely to be appropriate”. Likely to be announced in Nov, commence in Dec.
• Tapering could be conducted at a quicker pace than the market thought before. « Taper could conclude around the middle of next year. » This implies a rate of $20bn monthly, which arguably, by getting the tapering done early, offers the Fed more scope to raise rates sooner without alarming markets yet.
• Quicker pace to taper could suggest faster rate hike cycle, curve flatter but long-end rates should start to pick up and steepen
• Employment goal all but there – Powell: “My own view is the test for substantial further progress on employment is all but met”. This somewhat begs the question as to why the Fed is not already tapering and on course to raise rates in order to temper inflation expectations that are running wild.
• So the Oct 8th NFP report will be of great importance – “The test is accumulated progress. For me, it wouldn’t take a knock-out, great, super strong employment report”
• Inflation is stickier and far less transient than previously thought. Core PCE revised up 70bps to 3.7% this year, also revised up next year.

The core PCE inflation number for this year was hiked to 3.7% from 3.0%, the 2022 figure to 2.3% from 2.1%. They’re pulling out the ‘transitory but not quite as transitory as we thought’ line. I called 3.5% for 2021 and 2.5% for 2022 – so Fed still frontloading inflation expectations here – more in 2021, cooling sharply next year. The question is whether these will need to be revised higher again and what this could mean for rate hikes.

Fed inflation forecasts 23.09.2021

More policymakers see rates rising in 2022 and near-term inflation forecasts are being revised higher. On the other hand, growth and unemployment forecasts are not as bullish and the Fed has not tied its colours to a particular date to begin tapering asset purchases.

Since June, policymakers have become noticeably more hawkish, partly due to the recovery – Delta concerns have greatly eased since then – and partly due to the persistent inflation narrative. Nine policymakers see rate rising next year, whilst the median dot sees three hikes each in 2023 and 2024.

Fed Dots 23.09.2021

Big tech facing a watershed? Every action has an equal and opposite reaction – and I sense we are ready to see that reaction for some key momentum-mega cap growth names.

Facebook is facing a stern test with some major new allegations filed in a Rhode Island lawsuit. In summary, the plaintiffs allege FB spent billions to protect boss Mark Zuckerberg personally. Specifically, they claim the company paid $4.9 billion more the Federal Trade Commission sought in relation to the Cambridge Analytica scandal in order to shield its CEO from being held personally liable for “failing to oversee privacy at Facebook”. The suits also allege that there were « epic corporate governance breakdown » and details massive « insider trading », whilst also claiming Zuck misled Congress. Anyway. it’s a hornets’ nest of SEC-related failures.

The insider trading bit relates to hundreds of millions to billions made by corporate insiders who would have been aware that the ‘hypothetical’ risks to the company were in fact fully realised harms. For more read this excellent thread. Facebook shares fell 4%.

I don’t know if it gets anywhere. But I sense winds of change for big tech. Tesla is being investigated at long last over autopilot, Gensler has taken a hard line on cryptos and put Coinbase back in its box. The laissez-faire approach under the Trump administration looks like a thing of the past.

Briefly:

• Robinhood shares rallied 10% on news it will launch its own crypto wallet for users to hold physical Bitcoin etc
• Cathie Wood reiterated her $3,000 PT on Tesla, says she would sell out if it hit that level next year.
• Royal Mail shares flat to negative despite growing revenues almost 18% over 2019 levels. Outlook maintained with group adjusted operating profit for the first half of 2021-22 is expected to be £395 to £400 million.