US Equity Market's response to possible Fed rate hike tomorrow

Here's what John Hussman had to say about this matter in his weekly newsletter this week.

“First and foremost, the response of the equity markets to Federal Reserve easing (and much other news) is conditional on the risk-tolerance of investors at the time, which we infer from observable market action such as internals and credit spreads, among other factors. Quantitative easing ‘works’ by creating default-free liquidity in an environment where that liquidity is viewed by investors as an inferior asset. That is, if investors are risk-seeking, as inferred from the uniformity of market action across securities, sectors and asset classes of all risk profiles, then yes – Fed easing will tend to support further advances in stock prices regardless of the level of valuation. On the other hand, once investors have shifted toward risk-aversion, overvalued markets become vulnerable to abrupt free-falls and crashes, and monetary easing is not materially supportive for stocks because default-free liquidity is desirable. [Highlights in bold are mine.]"

In previous weeks and months, investors have been shifting to risk aversion, according to Hussman's inferences from observable market action. This means that downside risk exceeds upside potential ...

Hussman further says in this week's newsletter that,

"A quarter-point hike will not cause anything. The causes are already baked in the cake. A rate hike may be a trigger with respect to timing, but that’s all. [Highlight is mine.]"

Author is also on Twitter.

On tomorrow's Fed decision to hike rates

for the first time after 11 years

Tomorrow will be the first time since 2004 that the US Fed may raise the Fed Funds rate. (See this source for historical rate hikes including the one from 2004.)

Here are a couple of opinions as excerpted from John Hussman's weekly newsletter for this week.  

In brief, (a) it doesn't matter to the real economy and (b) not raising rates increases the risk of financial dislocation and global recession. Item (a) is Hussman's opinion and (b) is Albert Edward's.

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Here's Hussman's opinion.

"With regard to a possible quarter-point hike this week in the amount of interest that the Fed pays banks on idle excess reserves, our view – frankly – is that it doesn’t matter. [Highlight is mine.]" 

"With respect to the economy, we know that a quarter-point means nothing, given the weak correlation between policy rates and subsequent output, employment and inflation. From a purely economic standpoint, my impression is that the main effect of hiking interest rates would be to draw zero-interest currency into the banking system in the form of even more idle reserves. We’re already seeing indications of an economic slowdown, but the impact of a quarter-point hike on that dynamic is meaningless. The economic slowing we’re seeing here – which as yet isn’t strong enough to warn of recession – was already developing in February (see Market Action Suggests Abrupt Slowing in Global Economic Activity) and based on declining new orders, falling backlogs and rising inventories, is still underway. [Highlights are mine.]" 

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John Hussman also provides Albert Edward's opinion from SocGen the French bank. His view is as of last week.

“The clamour for the Fed not to enact the long-awaited ¼% rate hike next week is growing by the day. Misgivings come not just from reputable mainstream commentators, but now also the World Bank has repeated the IMF’s recent words of caution in advising delay. What a load of nonsense! My esteemed colleague Kit Juckes characterizes the current consensus thinking as ‘If the Fed hikes, pestilence, plague and never-ending deflation will follow.’ Well even those like me who see a deflationary bust awaiting think the Fed should hike next week – because the longer you leave it, the bigger the financial market excesses become, and the bigger the risk of financial dislocation and global recession ensuing. Have we learned nothing from the 2008 Great Recession? Just get on with it! [Highlights are mine.]" 

Author is also on Twitter.

US Fed Funds Rate Impact on GDP Growth

Historical evidence suggests that for every 1% decrease in the Fed Funds rate GDP growth rate increases by 0.1% which is not a whole lot. 

Unfortunately, the accuracy of this relationship is only 4%!

The above information was extracted from John Hussman's weekly newsletter for this week.  Please see the chart below which is the first chart in that newsletter.

Author is also on Twitter.

On the Correlation between Unemployment & Inflation;

also, known as the Philips Curve

This is what Econ 101 teaches us about the relationship between unemployment and inflation. It's called the Philips Curve.  Apparently, the US Federal Reserve bases policy decisions on it.

Here's what quantitative equity fund manager John Hussman has to say about this relationship.

"You’ll find a ... shotgun scatter of uncorrelated points if you plot unemployment versus general price inflation, for example. It’s unfortunate that the Federal Reserve is actually allowed and even encouraged to impose massive distortions on the U.S. economy based on relationships that are indistinguishable from someone sneezing on a sheet of graph paper. [Highlights are mine.]"

In a nutshell, the Philips Curve is a fallacy.

The above quote was excerpted from Hussman's weekly newsletter for this week.

Author is also on Twitter.