Editor's Note: This is a special Hedgeye Guest Contributor note written by Mike O'Rourke. Mike is the Chief Market Strategist at JonesTrading where he advises institutional investors on market developments. He publishes "The Closing Print" on a daily basis in which his primary focus is identifying short term catalysts that drive daily trading activity while addressing how they fit into the “big picture.”
“Forward, the Light Brigade!”
Was there a man dismayed?
Not though the soldier knew
Someone had blundered.
Theirs not to make reply,
Theirs not to reason why,
Theirs but to do and die.
Into the valley of Death
Rode the six hundred.
Alfred, Lord Tennyson
Tennyson’s poem about British troops following their leaders to tragic death in the Crimean war was the first thing that came to mind as headlines crossed the wire stating the Bank of Japan will explore expansion of its Negative Interest Rate Policy (NIRP). The hallmark of twenty first century Central Banking has been to enact an extremely accommodative and unconventional policy and then to expand it when it fails. The failures of the Central Banks becomes more and more apparent with every day that passes. The record amounts of accommodation that have flooded the global economy over the past 8 years have failed to create economic momentum. Central Bankers don’t know when to tactically retreat, cut their losses and seek a new plan of attack.
In the end, the public will pay the price.
The past few trading days have been nothing short of remarkable. Friday’s large market decline was followed by an inexplicable sharp rally which was compounded by highly misplaced expectations on a Fed governor’s speech. Most of yesterday’s rally was erased today with no clear catalyst driving the market wide reversal of momentum. After two months of recording no daily changes of 1% or more, 3 have been recorded over the 3 consecutive days. In early August, after the release of the strong July employment report, we asserted the FOMC should be on pace to resume tightening with one caveat - “Market volatility” would be another surefire event that will prevent the FOMC from carrying out its intended wishes. The irony is that if the summer continues its slow uneventful pace of the past month, the likelihood that the FOMC will resume tightening rises significantly. The best hope to prevent Fed action would be another market temper tantrum.” We have noted repeatedly that if the top Fed officials are taken at their word, the FOMC should tighten next week. But the market does not share our view. Could this behavior simply be the market’s temper tantrum to ensure the FOMC does not tighten?
Another potential explanation is the market is finally acknowledging there is no free lunch and the “lower for longer rate outlook” is accompanied by the disappointing growth outlook. Governor Brainard’s speech yesterday was a more dovish version of Chair Yellen’s Jackson Hole speech. The market’s reaction to Yellen was mild. At the time, we noted “While the market continues to celebrate a lower for longer environment, it misses the likelihood it will also be significantly tighter than the environment of the last several years. In short, the Fed has said we are going to resume tightening, but our outlook for longer run growth is weaker than any other point in the recovery. That hardly seems to be a good reason for markets to be in a volatility void.” Similar to Friday, a key aspect of today’s selloff was the bond market weakness. While Treasuries led equities lower Friday, today equities led treasuries lower (chart below).