The Market Has Spoken: The Fed Made A Policy Mistake And “Quantitative Failure” Looms – What Comes Next

Now that the Fed’s rate hike is in the history books and Yellen is eager to demonstrate that the Fed is confident enough in the US economy by unleashing the first tightening cycle in nearly a decade, market participants are dramatically shifting their attention, from the rate hike as a bullish key catalyst in the “renormalization” timeline (“buy stocks” because the Fed wouldn’t risk recession if it wasn’t confident in the economy), to the actual consequences of the Fed’s dramatically changed reaction function, which as we explained previously, was far more hawkish than the market initially expected. 

Most important however, as we have repeatedly discussed ever since August, is the market’s obsession with whether the Fed just made a critical “policy mistake.” As Bank of America’s Michael Hartnett, one of the foremost skeptics that the Fed is doing the right thing, explained previosly, “the “tail risks” to “deflationary expansion” are high. Like a game of Jenga, a bull market built by central banks can collapse if further BoJ/ECB QE and Fed hikes engender US dollar spikes & US EPS & EM/commodity swoons, FX-wars & volatility rather than a fullblown recovery.”

The threat, therefore, is that after “Quantitative Success” pushed up stocks from 666 to over 2,100 in 6 years, the opposite may be on deck now, hence the neo-narrative of Quantitative Failure and the dual risk that:

For signs of the first look no further than the market’s profound disappointment with the BOJ announcement on Friday morning, which sent the Japanese Yen plunging at first, only for the carry currency to soar once the market realized that the BOJ’s ability to intervene in markets may be far more constrained than had been anticipated, as we showed yesterday…