The Fed insists it will keep its feet on the ground for a long time to come, purposely running a “high-pressure economy” until the pandemic and its hereditary effects are safely behind us. But what the federal government wants to do and what the markets will allow it to do are not the same thing.
ING’s Chris Turner and James Knightley say the Fed will soon come under “real pressure to justify what it’s doing.” They believe he will be forced to start phasing out bond purchases by the fourth quarter of this year. The Fed’s Jay Powell will therefore have to start appearing more belligerent several months earlier to avoid a major market shock.
This is also my point of view at this point. If this is correct, we can expect more typing speeches from regional Fed chairmen – the supporters of the relative hard line – followed by a few fancy footsteps from Mr. Powell in May or June. Ergo, it may be another two or three months before the world’s hegemonic central bank begins to take the bowl of punch, with a hangover awaiting tech stocks, junk bonds and Bitcoin – although the raw materials are just beginning.
Candace Brown of Bank of America says we are “very close to the threshold of euphoria, if not already there”. The bank’s survey of global fund managers shows cash levels are at an eight-year low at 3.8%. The Bull & Bear indicator is in an advanced greed phase at 7.4. But it has not yet reached the danger level of 8.0, when smart money takes its profit and prepares for a squall.
We can pull the trigger too soon. Ms Brown says the circumstances of the pandemic are sui generis and we are inundated with global liquidity. Normal valuation metrics (P / E, P / B, EV / Sales) may be near all-time highs, but they are being overtaken by what she calls “convexity,” a non-linear rise in price / earnings multiples.
Yields on 10-year US Treasuries have risen 46 basis points to 1.38% since early January. The rule of thumb is that a 50 point hike in a month equals a mini-typing shock. If this persists, the problems increase exponentially.