A MIDSUMMER NIGHTS DREAM – TAKING STOCK
As we lament the fact that we have already reached the mid-point of summer, it also proves an opportune time to review the broader themes that have and are impacting valuations. As we began the year, the thesis of monetary policy divergence proved highly disruptive as the Fed was set to embark on its first rate hike since reaching the zero lower bound almost 7 years ago. This belief clearly stood in contrast to the policies of the vast majority of developed and developing central banks who were either firmly ensconced in the rate cutting process or were going directly towards QE bond buying. Nowhere was this clearer than contrasting the tighter monetary path the Fed was moving towards versus the 700 billion euro QE program announced by the ECB. The stronger dollar/weaker Euro were the most obvious byproducts of this divergence, although ancillary moves in global rates, commodities, and disparate equity markets were no less dramatic. Our interpretation of Chairman Yellen’s Congressional testimony today continues to signal the Fed’s desire to hike rates later this year. The somewhat muted response from the market is indicative of either skepticism towards her ability to fulfill the rate hike goal or prices that already reflect a slow and gradual hiking process. At this point, futures point to December as the likely liftoff date, with only a 35% chance of a hike in September. The expected path of hikes also remains muted, with market expectations for only one additional hike by mid-2016. This stands in contrast to market expectations at the start of the year, which saw the first rate hike in August, (which has a 13% chance according to the futures market) and a much more aggressive path of hikes that expected 4 additional hikes 6 months after the initial lift-off.