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Update: Tighten Up

By beled | October 29, 2018

Extract from the September 2018 quarterly report:

Equity prices have recently experienced sharp corrections amidst concerns that the US Fed may pick up the pace of its interest rate hikes. Quoting Donald Trump: “I really disagree with what the Fed is doing. I think the Fed is making a mistake. They’re so tight. I think the Fed has gone crazy.” So is he right? “Crazy” might be too strong a word but there is no doubt that since Q1 2018 the Fed has been tightening monetary policy by selling securities such as Treasury Bills (TB’s) which takes liquidity out of the financial system (chart 1). One could even make a case that monetary policy has been tightening since quantitative easing (QE) ended in 2014. As the Chinese proverb says, “When there is no gain the loss is obvious!”. In any event by their own admission the Fed is no longer accommodative.

Chart 1: Assets of the the US Federal Reserve (August 2018 report)

On balance we feel that the Fed will act responsibly and only raise target rates reactively to good economic data. The NY Fed’s model to which we referred last quarter still shows the probability of a US recession to be low and for the time being we are prepared to give this robust indicator the benefit of the doubt. Perhaps Christine Lagarde (MD of the IMF) summed it up best when she said “I wouldn’t associate (Fed chairman) Jay Powell with craziness. He comes across – and members of his board – as extremely serious, solid and certainly keen to base their decisions on actual information.” Accordingly we remain of the view that US yield curve inversion (when the US 3m TB rate increases over and above the US 10 year bond rate) should be our red flag of choice in calling an end to the US equity bull market.

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