Monthly Market Update: Can the Fed be the answer to everything?

Thu 16 Sep 2021

For a long time our central theme has been the disconnect between the real and the financial economy. Nowhere has this disconnect been made
more clear than in the Fed’s communication in August. The bullish economic outlook clashed directly with a dovish approach on interest rates.
Actions speak louder than words, however, and it is becoming apparent that the world’s de facto central bank is positioning for macroeconomic volatility. The data confirmed as much : US payrolls came in at a third of expectations and PMI indices in China and India suggested manufacturing stagnation. Manufacturing reports suggest that export orders are losing momentum, potentially indicating industrial weakness for the west in the next few months. Payrolls continue to be affected by the advance of the Covid-19 Delta variant, which keeps many parents/income-earners in a fluid condition.

Both the Fed and the ECB have been hesitantly talking about tapering asset purchases. In this volatile environment, however, it is difficult to see
how central banks can reasonably justify the removal of ultra-accommodation. On the other hand, supply driven inflation, a result of shortages and economic arrhythmia, could well continue to advance.

Despite the welcome dovish stance, investors need to remain vigilant. There is a very thin line between monetary exuberance driving equity and bond prices higher and the markets realising that central banks can neither control supply-side inflation nor exit quantitative easing. It is the thin line that not only separates buoyance from panic, but also one that, if crossed, may lead to a paradigm shift.

In other words, it is conceivable that we are drawing closer to the end of a twelve-year course where the underlying tenet of every investor was ‘Simply don’t fight the Fed’. This tenet may well be replaced with ‘The Fed is not the solution to literally everything’, opening up a whole world of opportunities -and risks. A paradigm shift is usually a volatile affair. It would allow the central banks’ political bosses less leeway to pander to the fringes and assign a greater impact and higher downside to the decisions of
governments.

However, we are not there just yet. Investors should remain diversified and patient with volatility. As portfolio managers, we try to ensure that we are active enough to recognise opportunity and that there are more ‘bets’ in our clients’ portfolios other than just equity ‘beta’. -George Lagarias, Chief Economist