Markets are voting with their feet

Outlook:

The markets are voting with their feet—after a long period of uncertainty, they now think the Fed will not change its language in today’s Statement and we will not be one inch closer to having a date for the First Rate Hike. The 10-year yield and dollar are down, and equi-ties are up.

After the taper tantrum, the Fed knows that managing expectations is equally important as getting the policy right. Fed-watchers zoom in on two statements, the first being the “significant underutilization of labor resources.” Despite a monthly average of job growth by 215,000 so far this year, Yellen thinks there’s a way to go before we get full utilization of labor. There is some slight chance the Fed will change the word “significant” but on the whole, Fed-watchers think this phrase will remain exactly the same this time.

The other key phrase is “considerable time,” referring to the period after the end of tapering and the First Rate Hike. The Fed statement has used this language since March and it’s too vague. Hawks would like to a see a modification. One reason to suspect a change is that this is one of the times we have a press conference—the next one is not until the Dec 16-17 meeting. The press conference gives Yellen a chance to elucidate any small language change. Another reason to suspect a language change today is the first appearance of the 2017 projections from the Fed staff. Linking the First Rate Hike to develop-ments in employment, growth and inflation removes the idea of a calendar date—it removes “time”—and has the virtue of being consistent with data-dependency.

You can herd cats if they are hungry enough. But you have to admit it’s sad and funny at the same time that the fate of the financial world depends on two adjectives. The real problem will be if the Fed leaves all the language the same and postpones any changes until after QE is officially dead, which doesn’t come until the October meeting. Or maybe do nothing in Sept or Oct and wait until the Dec meeting, which is the next one with a press conference. This has a certain logic, too, and gives the appearance of a steady hand on the tiller, even if it infuriates some academics and many traders. The FT notes, perhaps tongue-in-check, that keeping “considerable time” until December means Yellen’s mention of six months will come true and become the definition of “considerable time” in Fed-speak. We doubt it and that’s too cute, but just wait.

We say that if the Fed leaves the language the same, we get a new low in the 10-year yield, the dollar continues to crater, and some smart guys will make a killing on recovery in some emerging market cur-rencies. Justification for delay is not hard to find—slowing global growth, cheap commodities, weak inflation, weak housing, the Scottish referendum, and most of all, fear that the market has not yet been adequately prepared. Some idiots are sure to take removing the word “considerable” to mean the First Rate hike is in Q1, not June or “summer,” and set off a storm. In other words, the Fed has not done much to prepare the market—just a few hawkish comments here and there—and that very lack of preparation means we should not expect any change—this time.

Bottom line, the oblique, opaque manner in which the Fed communicates with the markets is very, very bad. They trumpet transparency when it’s anything but. We appreciate why he did it, but Greenspan did us all a great disservice. Yellen should come right out and say the First Rate Hike will not come until “summer” or later, depending on data.

But in the absence of any preparation comments, probably from Yellen rather than the Statement, we have to accept that the dollar pullback/correction is the real deal. Eventually the rally will resume, but this time the Fed has shot it in the knee.

Meanwhile, across the Pond, the consensus has it that Scotland will not vote for independence, 16-year old voters notwithstanding. The pound has already recovered about 50% of the fear-induced drop, and closed the downside gap that appeared on the poll showing the Yes vote winning. We worry that the UK hike, still mostly seen as coming in Q1, will be newly seen as delayed to later, undermining sterling. We wouldn’t be too fast to bet the ranch on long sterling.