The summer is coming to an end without much success at the movie box office, but one "sequel" has emerged a winner this week although its ultimate fate awaits further developments.
Readers of this blog will recall that questions were raised here in late August last year about the steady drumbeat of financial market expectations that the Federal Reserve Board's Open Market Committee would announce that it would commence "tapering" its program of bond purchases known as Quantitative Easing III which was intended to stimulate increased economic activity. Speculation that this would happen had begun late in the spring and continued throughout the summer based on a response by then-Fed Chair Ben Bernanke to a question at a Congressional Committee hearing as to whether such tapering would ensue by Labor Day. Bernanke said if the economic conditions improved sufficiently, tapering could be commenced "later in the year."
In the wake of those comments, interest rates on ten-year Treasury securities spiked upwards rather violently, causing the stock market to swoon down as well. Commentators parsed every word and phrase used by Fed Board members over the summer months, and some commentators even detected that the Fed had actually "said" it would taper in September (Dennis Gartman live on CNBC). This was, as a matter of record, completely untrue, but by then the market was definitely in a "print the legend" mood.
In particular, hedge funds that had in 2013 and 2014 staked out a net short position in both the stock and bond markets (and as a result were carrying massive losing positions for their clients into the summer) were salivating at the prospect of reversing their fortunes thanks to the market perception that the Fed would move quickly to begin to reverse its "highly accommodative," easy-money policies. Any perception of monetary policy "tightening" was then likely to send both bond and stock markets down as it did, thus bailing out the short hedgies.
Well, it didn't all work out that way. The Fed in fact took its time to get more and better data before it began tapering; the markets, after the initial September surprise rather than the "expected" (or at least highly promoted) idea of a "Septaper." That timing was always premature, as anyone who was paying attention to this blog, or more importantly to Chairman Bernanke when he called out the anticipatory run-up in interest rates, caused by those twisting his words on TV for self-serving purposes into a "Septaper" commitment, as distinctly "unwarranted." Yet many fools and their money were parted by the wily hedgies, who were sucked in the Cable TV producers anxious to have a crash to cover (or at least call it in advance).
The only clear winners were the hedge funds. Having scared so many into selling in advance of the "Septaper," which turned out to a be as much a phantasm as the El Nino that never came to spare us the brutal 2014 winter, they were in pole position to scoop up bonds and stocks on the cheap and profit from the inevitable rally that they knew damn well would come when the expected (but in hindsight clearly premature) "Septaper" didn't happen!
Does all this sound a bit familiar? It should. The hedge fund market players find themselves in the same position as they were last summer: short and wrong. Both stocks and bonds based on ideology or just dogged insistence that both markets are long overdue for a "correction," as more than one CNBC commentator confidently predicted was on the visible horizon as summer's end approached. The crises in Iraq, Israel and Ukraine were cited by certain large investors as firm grounds for a severe market crash of up to 60%, others disagreed, contending the market has more room to run up, despite the international situation. And for a while this September, that view carried the day as markets continued their climb. No doubt, this was much to the chagrin of the short hedge funds, who by now were counting on a literal re-run of the play from just 12 months ago.
But before the market open on Monday September 8, the shorts got a gift that kept on giving right through the week thanks to an overnight Financial Times article suggesting that the Fed's standing policy that interest rates would not be increased ("tightening" policy) for a "considerable time" - generally thought to mean about six months - after the end of QE III would at least "at the September 16-17 meeting, based on conflicting comments some of both the "hawk" and the 'dove' rates camps within the Board. The article went on to speculate that a decision to change this policy statement to a more hawkish posture (presumably a less "date-based" fixation and a more purely "data based" giving emphasis to improving economic statistics) was not in fact likely until the late-October meeting. Market commentators, however, perhaps egged-on by hedge fund shorts who saw a chance to snatch victory from defeat with a last minute "Septaper 2.0" play, ran with the mere possibility and turned it into a virtual certainly of a policy tightening change at the September meeting!
By Friday, the bond market had rung up bond yields to over 2.60 from a level closing in on 2.30 just a couple weeks ago, bailing out bond bears, and the equity markets had turned south with a first losing week in six. Even seasoned and respected CNBC market analysts like Steve Leisman and Art Cashin had jumped on the "Septighten" bandwagon by week's end. Leisman cited observers who focused on a very recent San Francisco Fed paper calling attention to the gap between Fed member's collated estimate of a 1.2% overnight money rate by year end 2015 versus the trading market's expectations are anchored at .76% as evidence of a Fed desire to change its guidance sooner rather than later to tighten up that gap. And Cashin, by week's end, was telling listeners (including this writer) near the close of trading that markets now "expect' a policy change at the September meeting.
To be clear: Leisman and Cashin are certainly not manipulators. They are simply reporting the extent to which the market has talked itself from a "possibility" into a near certainty. And yet others were not so sure, as Barron's reported, citing a leading analyst to the effect that the Fed may be even more concerned that a guidance change just now might lead markets to get ahead of the Fed in terms of the likely onset and pace of rate tightening. That problem would be harder to fix than the opposite case.
The sense here is that the latter analysis points to a similar result as with "Septaper" expectations in September last. Fed Chair Janet Yellen will wait one more month to be more certain of the overall direction of the job market and the economy and how employers are approaching them in their 2015 planning cycle. She will have September payrolls and the latest read on both Q2 and Q3 GDP, so a "data-based" change would be far more appropriate around Halloween than the Autumnal equinox. Like Margaret Thatcher, "the Lady's not for turning", even by the hedge funds!
By Terry Connelly, Dean Emeritus, Ageno School of Business, Golden Gate University
Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education.