Romance with Fed pivot breaks investors’ hearts

Last week was cruel for traders and investors who were hoping that financial markets would leave behind what has been a painful triple whammy this year caused by tightening financial conditions. After a strong bounce in both stocks and bonds early in the week offered some hope, the markets yanked it back, essentially erasing investors’ gains as investment portfolios resumed their record-breaking downward trajectory.
On the surface, investors would appear to have only themselves to blame for this whipsaw, given the sharp contrast between their romancing, yet again, the idea of a Federal Reserve “pivot” and what, for once, has been consistent messaging from central bank officials that no such policy change is in the offing. Below the surface, however, the situation gets more complicated.
The hope early last week for a Fed pivot was born of three developments. First, Australia’s central bank increased rates less than the consensus forecast; second, the Institute for Supply Management’s measure of US manufacturing activity came in weaker than expected; and third, investors extrapolated from the Bank of England’s emergency market intervention to avoid a potential “meltdown” — to use the word from the deputy governor’s explanatory letter to Parliament — to conclude that financial stability concerns would add to recession worries in getting the Fed off what, at least for now, is the most front-loaded rate-increase cycle in recent history.
By the end of the week, all these hopes had been dashed, mainly both by consistent statements from several Fed officials and by a monthly unemployment report that was widely interpreted as consistent with yet another big rate increase at the next FOMC meeting in early November. It also did not help that the OPEC+ decision to cut output by 2 million barrels a day pushed oil prices back above $90 a barrel.
Once again, investors and traders experienced that awful trifecta of disappointing returns, unsettling volatility and the positive correlation between risk-free and riskier assets that robs investment portfolios of their ability to mitigate risk by diversifying between stocks and bonds.
In the past, such a “pivot whipsaw” would normally have been due to some off-the-cuff dovish comment by Fed Chair Jerome Powell that suggested a replay of his big U-turn in the middle of the market volatility of the fourth quarter of 2018 — that is, the notion that the long-standing Fed “put” was back in the money.
Not this time. All Fed speakers, and there were many, reinforced Powell’s latest narrative that the policy battle against inflation is “unconditional” and that the Fed “would keep at it.” There was no hint of any backtracking.
—Bloomberg