Powell’s speech confused the markets

What happened? Why did the market initially react positively to Powell’s speech, but then abruptly changed direction?

Initially, as you and I expected, Powell’s speech was as follows: we do not plan to stop providing liquidity immediately; everything will go according to plan. That is, tapering should be completed by March.

“Hooray!” the markets said. Everything is great. But the joy did not last long. Just a few minutes. And then the hardest part began.

Here are quotes and market reaction to them.

“We have not made any decisions regarding the timing and pace of balance sheet reduction.”

In other words, now let’s think about it and make a decision. The markets did not seriously mortgage this move. More precisely, earlier there was an understanding that the sale of assets from the Fed’s balance sheet is an extreme measure. And, apparently, if they decide on it, it will not be very soon. And here already quite transparent hints. Investors got scared and ran to sell.

“We don’t rule out rate hikes at every FOMC meeting.”

Again, harsh. Initial expectations are 3-4 rate hikes in 2022.

“The labor market is set for maximum employment.”

In other words, employment is good. And no surprises are expected here. As a continuation:

“There are quite a few opportunities to raise interest rates without hurting employment.”

“We will provide more information about the balance reduction when the time comes.”

Well thanks, cap. And when will this time come?

“Fiscal stimulus for growth will be significantly reduced, which will also help bring down inflation.”

Oh, a clear hint of an imminent tax increase. Another thing, it is not entirely clear – what does the Fed have to do with it? However, raising taxes is also a kind of anti-inflationary measure. This is what ultimately compresses demand and lowers the level of consumer activity.

“We really want to reduce the balance sheet, primarily by adjusting reinvestment.”

But this phrase was clearly superfluous. The people got nervous. Well, we talked once about selling assets from the balance sheet, and that’s enough. Why make people nervous?

How could the market, after repeated mention of the topic of selling assets from the Fed’s balance sheet, not get scared? This is a very serious mechanism for drying up liquidity.

Markets literally lost all their growth in a few minutes. The song about hares seems to have been forgotten for a long time.
Strengthening against other currencies has begun. lost more than a percent in value. Yields on closely approached the level of 1.85.

We expected that the market rebound would be short-lived. It was not in vain that I said yesterday: do not rush to buy. But that everything will happen so quickly …

What can we expect now, given the additional factor – the growing geopolitical tensions?

1. Dollars against other currencies. This is perhaps the key indicator today. Will the further strengthening of the dollar? It’s not clear yet. But it seems today that there is not much significant purely economic potential for further growth of the dollar. However, in the event of increased tension in Europe, the dollar may strengthen further.

2. UST yields. On the one hand, they can easily reach 1.95-2% amid fears that the rate hike will be multiple and sharp. On the other hand, fears will push investors to purchase this instrument as a kind of safe haven. So, most likely, the further growth of profitability will not be so fast.

3. Gold. A faster-than-expected rate hike could well play against gold. Just like the growth of the dollar against other currencies. But the increase in geopolitical risks is a factor clearly in favor of the growth in the price of gold. Despite the fact that gold has lost its growth of recent days, the medium-term trend has not yet been broken. There is a chance for continued growth, and not a small one. Until I sell shares of gold miners. There is a chance that under the circumstances they can still act as a quality defensive harbor.

4. . Prices sank a little on the general wave of sales after the “kind words of parting words” from Powell. However, the growing geopolitical uncertainty associated with the world’s largest oil exporter will not allow oil prices to sink much. Moreover, here we can see the continuation of the rally up to $100 per barrel.

5. Stock markets. Are under serious pressure after “good parting words from Powell”. As we remember, at the end of 2018, we already watched how the FED decided, by raising the rate, at the same time to start the process of selling assets from the balance sheet. The falls then were short-lived, but more than serious.

Will history like this repeat itself? Not sure yet. Fundamentally different situation. And there is more than enough liquidity today. The technical picture so far is that if the markets hold the level of 4250 at , then, no matter how funny it looks today, we can see continued attempts to grow. The chance for that is not too great yet. But… he is.

The key day in this case is today. What will happen if the markets still try to scare everyone?

I think that a huge amount of funds awaiting market drawdowns will not let it fall by more than 4-6% from current levels. Protective industries will look, without any doubt, the shares of the military and gold miners. In the event that oil prices continue to grow, oilmen may also join them.

6. in this situation, when there is an overlap of both geopolitics and global market risks, it will continue to be under pressure. Yesterday’s explicit interventions by the Central Bank brought the ruble back below 80. In principle, the Central Bank still has enough resources to support the ruble exchange rate. And we will follow developments.

Judging by the picture that we have today, anything can happen. The risks have increased significantly. The situation of the conflict has moved to a fundamentally different level. The chances of a bad turn of events, which we previously assessed as relatively low, have increased dramatically. In my opinion, if they are quantified, then from 10-15% they began to approach 50-60%. Draw your own conclusions.

What are we doing now?

1. We look at the dollar against other currencies. The departure of the currency pair below 1.12 does not bode well for the markets.

2. We are looking at profitability.

3. We do not increase risky positions. Do not pyramid in the hope of “what if”. And suddenly it may not be. At least in the moment.

4. If possible, again we can buy a little more safety tools. Might come in handy in the coming days.

5. The main thing: do not need a lot of activity. Today, excessive fuss can lead to big losses.