Loading ...And whereas traditionally the Fed has stepped in to offset any stock weakness, either through direct action (delaying of rate hikes, or verbal jawboning), this time the imperative for the Fed is different: as Kocic explained above, weaker equities are consistent with ongoing term premium recovery because of the implications for pension investor flows.
Or, in simpler terms, the Fed wants higher long-term yields:
Stable equities slow corporate plan convergence to full funding, and obviate the need to rebalance equity gains into fixed income. Historical evidence suggests that state and local pension investors might “re-risk” on the margin given equity underperformance relative to fixed income.
Which brings us to the big question, namely whether given the recent equity rout, the Fed might deviate from its own median projections to the dovish side. As the discussion above suggests, which if accurate would imply that the Fed hopes to push yields higher through the equity vol channel, this is unlikely to happen if all the Fed can “force” is a 25bps equivalent tightening in financial conditions (via a 16% drop in stocks).
And sure enough, as we noted late last week, Cleveland Fed President Mester commented on exactly this concern, stating that “while a deeper and more persistent drop in equity markets could dash confidence and lead to a significant pullback in risk-taking
and spending, we are far from this scenario.”
Deutsche Bank agrees, and as its credit strategists argue “tightening financial conditions are one of the policy goals currently being pursued by the Fed to discourage excessive risk taking and promote financial stability.” ==
The tell? Keep an eye on rate vol: if and when it shoots up, that’s when the Fed may finally panic. And, as BofA’s CIO Michael Hartnett likes to remind his readers, “markets stop panicking when central banks start panicking.”