Jordi Visser Discusses The "real Risk" Of The Fed Not Moving

The following is an excerpt from Weiss’ newest recurring market commentary, Jordi’s Journal, which focuses on timely thoughts and musings on the financial markets.

A full copy of the piece is available here.

“Given that investors seem so dogmatic in their views that the Fed will not move regardless of the coming economic strength, I wonder if, instead, the real risk is the Fed does not move despite record economic strength and the market decides this is a mistake. This would not be the first time the market told the Fed or a government that they were making a policy mistake. For example, in December 2015, the Fed raised rates despite oil having fallen over 35% in the prior 6 months and the S&P 500 proceeded to fall 14% in the next 6 weeks. The Fed took note and did not raise rates again until December 2016.

This sounds simple, but the pressure point to watch is the unemployment rate. Remember that it peaked during the Great Financial Crisis at 10%. When the Fed first warned about tapering, the unemployment rate was around 7.5% and it was near 5% when the Fed first raised rates in 2015. Comparatively, the unemployment rate peaked at 14.8%, though it is already down to 6.2%. If it continues downward to 4% over the summer—and I think this is likely—there is a risk that we are underestimating how the market may react. In this scenario, my guess is that rates' volatility would rise significantly on the uncertainty of the Fed’s potential response. In turn, the rate volatility would have an impact on credit spreads and equity risk premium. I leave you with the famous quote from Mike Tyson, who said that everyone has a plan until they get punched in the mouth. There are unknown outcomes on the probability distribution and, from my experience, if the consensus is all agreeing, prepare for a punch to the mouth.”