One Trader Asks Whatever Happened To “Don’t Fight The Fed?”

Something appears to be off. After two consecutive admissions by Janet Yellen that the Fed has lost its grasp on the “mystery” of inflation, the market no longer appears eager to chase the direction of every Fed proclamation, especially the recent, hawkish ones. And, as Bloomberg’s Mark Cudmore writes this morning, “whether it’s because the Fed has lost credibility or just because Yellen is viewed as a lame duck approaching the end of her term, it doesn’t matter – U.S. rates and the dollar show investors aren’t buying what she’s selling.”

As a result, and because markets like narratives, Cudmore notes that “the combination of a freshly hawkish Fed and a potential tax plan is too appealing a story to ignore: it’s a tale of fiscal policy and monetary policy working together to support higher U.S. yields and a stronger dollar.” In short: the Bloomberg strategist is a big fan of being long the USD and short bonds here, unwilling to fight both a Trump administration dead set on cutting taxes, as well as a Fed where the divergence between its own and the market’s rate hike expectations is the widest it has ever been.

Then again, looking at the sharp move higher in the USD – and yields – in the past two days, the market may be coming round to the same conclusion.

Cudmore gives more reasons to just do it, and buy the dollar, in his latest Macro View note titled appropriately…

Whatever Happened to ’Don’t Fight the Fed?’

Investors may be suspicious of the Fed’s willingness to raise rates again in December, but this seems like a poor risk-reward time to fight the rise of U.S. yields and the dollar.

Janet Yellen was consistent in following up last week’s Fed meeting by reiterating that she’s keen to tighten again and isn’t worrying too much about the lack of inflation.

Markets shrugged. Traders aren’t yet convinced by another 2017 hike. Whether it’s because the Fed has lost credibility or just because Yellen is viewed as a lame duck approaching the end of her term, it doesn’t matter — U.S. rates and the dollar show investors aren’t buying what she’s selling.

People are likely to regret this cynicism, at least in the short term. Trump and Republican leaders are set to announce the long-awaited tax overhaul plan on Wednesday. With expectations so subdued, there’s a low bar to impress the market with some concrete details and nice soundbites .

The ability for companies to immediately write off capital expenditure for at least five years is one example of something the market would welcome, even if its ability to survive the legislative process is unknown.

The one-off profit-repatriation tax is also key. The reaction function of companies to different tax levels is still unknown but the dollar is likely to be boosted purely by the topic’s return as a discussion point.

Markets like narratives. And the combination of a freshly hawkish Fed and a potential tax plan is too appealing a story to ignore: it’s a tale of fiscal policy and monetary policy working together to support higher U.S. yields and a stronger dollar.

Never mind that the tax plan will struggle to get through congress and don’t worry that the Fed might be making a policy mistake. Those are issues for another time, not this week.

And dollar traders might want to register that while Janet Yellen’s term is expiring in 2018, she’ll still be firmly in charge for the December meeting. So maybe they shouldn’t be so quick to dismiss her policy views right now.