Key to Trigger Market ‘Inflection' Is a 1% Real Fed Rate, JPMorgan SaysBy
By the second half of 2018, Fed may have more of an effect
Real cash rate seen having more influence than yield curve
This year’s boom in financial markets has taken things to "late cycle," but the cycle has a little ways to go yet, according to JPMorgan Chase & Co.
The key trigger for an "inflection point in risky markets and volatility" will be when cash rates adjusted for inflation are at 1 percent, JPMorgan strategists led by John Normand and Dubravko Lakos-Bujas wrote in a Dec. 8 note. Currently, the rate is about negative 0.5 percent, measuring the upper band of the Federal Reserve’s policy target minus the consumer-price index excluding food and energy.
The next three to four Fed rate hikes should depress bonds and gold more than credit and equities, while boosting the dollar, according to the note. The analysts viewed the real cash rate as the key gauge to monitor, rather than the flattening of the U.S. Treasury yield curve that has preoccupied many observers in recent weeks.
"By Q3/Q4 2018, it will be worth rethinking the Fed’s role in late-cycle investing," they wrote. "This view is independent of the yield curve’s shape, which has little, if any, of the influence on the economy that the level of real rates does."
Real rates have been historically low thanks to the Fed’s go-slow rate rises since 2015. The next U.S. CPI report is due Wednesday, with the core measure seen holding at 1.8 percent according to economists surveyed by Bloomberg.
The soon-to-be two-year-old Fed tightening cycle has been unprecedented so far in that “real cash rates have never moved so little, the S&P never rallied so much, equity multiples rarely expanded so quickly (ex- the late 1990s/dot-com episode) and volatility never declined to such levels.”
It’s too early for stocks to stop outperforming, and JPMorgan equity strategists recommend boosting exposure to the tax-reform theme as they see the S&P 500 Index reaching 2,800 early next year if the tax changes are approved. That would mark a gain of about 5.6 percent from Friday’s close.
The bank’s strategists also see the dollar having some potential upside from tax-cut passage, and potentially the addition of another projected rate hike from the Fed in its dot-plot outlook due this week.
Among the markets that Fed tightening to date has failed to restrain, JPMorgan flagged bitcoin’s 45-fold price increase during the policy normalization cycle so far.
“If bitcoin had hopes of ever becoming legal tender -- meaning that all economic agents are obliged to accept it as payment -- then parabolic price momentum might be understandable,” the analysts wrote. “If not, this move seems like either a lottery ticket or the unfathomable price some will pay for the experience of interacting outside The Matrix.”