Take an Exit Row Seat

The talk in the Capital Markets, post taper, seems to be heavily tainted with certainty. This certainty involves a gradual glide path of rates, growth, employment, and inflation. However, as we all know, real life often intrudes on plans and projections. We have often spoken about the Fed and their attempts to influence investor expectations, particularly at the long end of the yield curve. However, it would seem that this latest round of Fed action appears to take this sentiment manipulation to a new level. While the Fed purports to have begun cutting their bond purchases by a meagre $10Bln per month, they explicitly reserve the right to move the goalposts as to when they may or may not cease altogether (employment or 2% inflation non exclusive). If the  U.S. Economy is getting better, by their own admission, then why must the Fed go to such great lengths to show markets that they” have their backs”. Is the Fed so concerned that this recovery is so fragile that even a 150 basis point back up in rates would completely derail the progress that has been made? Perhaps the Fed is more concerned with the markets level of certainty than they are with the efficacy of current policy. Evidence of this market certainty is shown in the total breakdown in the correlations between gold and the Fed’s balance sheet, post QE3. Prior to QE3 the correlation between gold and the Fed’s balance sheet was +.95%, and post QE3 that correlation had shifted 180 degrees to a -.94%. Thus if you take gold as a proxy for market uncertainty, QE3 only substantiated the markets belief that the Fed’s balance sheet would provide an seemingly endless backstop. In fact, a Fund manager commented recently on Bloomberg News that “Gold was probably one of the easiest shorts of all time”. When market dislocation and uncertainty are dismissed to this extent, it is time to start positioning one’s self by the proverbial exit door. Buy Stuff, Sell Paper.

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