Treasury secretary Janet Yellen said rates might have to rise to cool an overheating economy. Shock, horror. Did no one give her Powell’s script? “It may be that interest rates will have to rise somewhat to make sure that our economy doesn’t overheat,” Yellen said during an economic forum at The Atlantic. “Even though the additional spending is relatively small relative to the size of the economy, it could cause some very modest increases in interest rates.”
Economics 101 shouldn’t offend markets or perturb investors – stocks hit session lows off the back of the remarks. But this was seen as a significant remark since it is a break with the Fed’s new policy stance. Now what she’s saying is demonstrably true: central banks raise rates to stop economies from ‘overheating’, since this tends to lead to bad things like inflation and misallocation of capital. It’s the kind of thing central bankers would normally say in normal times to signal a tightening cycle is imminent. But we are not in normal times and the Fed has been hammering its message home that its goal is not to quell forecast inflation, but to get back to full employment come-what-may. Some will flag the potential incursion into monetary policy by the Treasury as big no, but in this instance it’s not about central bank independence – Yellen is far too well versed in this topic and far too academic in her approach to be trying to strong arm the Fed.
But it’s very much the antithesis of the way the Fed has been playing things since the pandemic. We’ve all kind of assumed the Fed is happy to let the economy run hot, because it’s implicitly said so: employment is the goal, inflation can be overlooked until enough people have jobs. Now many of us have questioned the sustainability of such a pivot in policy and break with the traditional central bank approach, which has always been to remove the punch bowl before the party got out of hand (overheating). But we’ve assumed that the Fed was so all-in it wouldn’t change course.
Of course, Janet Yellen is no longer ‘the Fed’. That’s now Jay Powell’s purview. Her comments - seen in isolation - are just the same in reverse as Mario Draghi’s persistent calls for economic, structural and fiscal reform in the EU. But she was the Fed chair so her words carry weight. Moreover, Yellen and Powell have been singing from the hymn sheet - they’re not at odds on this, which could lead some to think it’s part of the ‘masterplan’.
So, the question for market watchers is whether what the Treasury says about monetary policy is all that important. Yellen looks more like an interested outsider than a Fed mole. I don’t think it was choreographed to signal a Fed taper. I think it was a genuinely held belief that multi-trillion-dollar stimulus and infrastructure spending coming at a time of a major cyclical recovery and zero percent interest rates could lead the US economy to get a bit warm. Coming from a central bank background, it’s natural for her to think that ‘well we need to spend this money now, so rates might need to go up to compensate for all this extra money we’re printing at a later date’. It’s not, in my view, scripted policy manoeuvring. Just sensible observation – the Fed could do with this.
Indeed, Yellen later made these comments at the Wall Street Journal’s CEO Council Summit: “It’s not something I’m predicting or recommending … If anybody appreciates the independence of the Fed, I think that person is me, and I note that the Fed can be counted on to do whatever is necessary to achieve their dual mandate objectives.”
Market reaction? Rates were unmoved, with the benchmark US 10-year still nestled around 1.60% but richly priced tech stocks fell, leaving the Nasdaq down almost 2%, which would imply that rates might not be moving at the short end (I.e. her comments are not a taper signal), but investors do think cyclical and value areas of the market warrant more attention (rotation). If anything has been clear about the last few months, it’s that some corners of the market that have been overlooked by investors are gaining more kerb appeal as inflation expectations and nominal yields pick up. Yellen’s comments only further underline this trend. The S&P 500 wiped out Monday’s gains, sliding 0.7%. The DAX fell sharply but is up this morning as European markets stage a fightback. The FTSE 100 trades up 1% and making a fist of 7,000 again after pulling back from the 7040 area yesterday to finish well south of 7,000.
Where are stocks headed? We spend a tonne of time chatting about what signals central banks are sending and what vaccines might or might not do for the economy. But all you lot really want to know is where the market is going to be in a week, a month, six months maybe tops.
So given it’s early May and the market is permeated with a sense of trepidation as traders really do take one eye of their screens as summer approaches, now’s as good a time as any to look at the prospects for the broader stock market in the coming months.
The old ‘sell in May’ adage is doing the rounds of course. On seasonality, Stifel says: “We see the S&P 500 flat/down -5-10% May 1st to Oct-31st, 2021: Seasonality is especially applicable at this moment in time". And Bank of America notes that the May-October period has the lowest average and median returns of any equivalent six-month period, looking at data going back to 1928. Maybe there is something in the ‘sell in May’ trope. Certainly, given the run-up in equities we have seen, the well understood macro picture and the propensity for yields to edge higher, a period of cooling off seems reasonable.
Earnings are powering ahead – we're just entering the last stretch of a blowout quarter in both the US and Europe. But this has been largely priced. Can corporates keep up the pace? The second quarter is meant to be even better – stimulus cheques are back, and GDP growth is seen powering ahead. Markets may not truly reflect just how strong this recovery will be. According to the Atlanta Fed Q2 growth is seen at 13.2% and the US economy will exceed its pre-pandemic peak before the quarter is over (as it should when you have pumped something like 20%-30% of GDP into the economy by way of fiscal stimulus and emergency relief packages). The money supply has ballooned; now is the time for the velocity of money to recover. We should be careful; we are already seeing some heinous year-on-year chart crime as economies recover.
Spending seems to be strong as the reopening of the global economy, but companies are experiencing supply chain problems and raw material shortages. This ought to push up inflation, raising nominal bond yields (though not necessarily real rates), which could hinder equity market returns over the coming months.
What about sentiment? Clearly investors are very bullish right now – they’re pretty well ‘all in’. BoA notes that Wall Street bullishness is at a post Financial Crisis high. "We have found Wall Street’s bullishness on stocks to be a reliable contrarian indicator. The current level is 50bp away from triggering a contrarian “Sell” signal,” they write.
And the technicals? In short, the S&P 500 appears very over-extended at current levels and a retrace of around 400pts to 3,800 would be considered as the first stop in multi-month reversion to more sustainable levels. The Vix does not suggest market participants are overly concerned and some are making big bets on markets remaining tranquil for the next few months.
Valuations are harder to get a handle on – the Case Shiller PE ratio is at 37, its highest since the dotcom boom - indeed it has only ever been this high during that period of ebullience and irrational exuberance. But given the rebound in the economy and earnings taking place and expected to continue, this backwards-looking metric is probably less reliable now than at other times (the Fed has already made somewhat outdated as a gauge of stress in the market). Forward multiples are less exaggerated – about x22 the next 12 months earnings. This is still relatively high but until the Fed removes the punchbowl, it can be sustained. Margin debt has exploded, suggestive of a large amount of leverage in stock markets that could be exposed to a sharp correction, making a pullback self-sustaining.
Should you worry? A lot depends on monetary policy reaction function. In other words, how do central banks respond to changing economic circumstances. More simply, when does the Fed remove the punchbowl? To be even more precise, at what point does the Fed start to signal it might start thinking about turning the music off. Yellen may have fired the starting pistol, but I now think Powell and co will work hard to row that back and reiterate their commitment to employment goals – I don’t think that has changed.
It’s like a game of musical chairs where everyone has worked out that it’s better to rush for a seat when the compere is looking like he might press stop than wait until the music actually finishes. US economic growth and spending this year could be even stronger than expected – this could push the Fed to tighten policy sooner than markets expect - or as we might surmise from Yellen’s remarks, the fiscal impetus could force the Fed to move sooner than it thinks it needs to. But only if employment recovers to pre-pandemic levels. If it does not, the Fed could keep administering kool aid for longer. Inflation remains the big unknown and has the potential to derail growth. Either way, yields should tend to move higher over the summer as data comes in, this could drive up rates and hurt equities even if it also means a weaker dollar as real rates in Europe move up.
RISK DISCLOSURE STATEMENT In consideration of Safecap Limited (“Safecap”) agreeing to enter into over-the-counter (“OTC”) contracts for differences (“CFDs”) and spot foreign exchange contracts (“Spot FX Contracts”) with the undersigned (hereinafter referred to as the “Customer”, “you”, “your”), Customer acknowledges, understands and agrees that: 1. Trading Is Very Speculative and Risky. Trading CFDs and Spot FX Contracts is highly speculative and is suitable only for those customers who (a) understand and are willing to assume the economic, legal and other risks involved, and (b) are financially able to assume losses significantly in excess of margin or deposits. Neither CFDs nor Spot FX Contracts are appropriate investments for retirement funds. 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Where the CFD or Spot FX Contract is settled in a currency other than your base currency, the value of your return may be affected by its conversion into the base currency. 12. One Click Trading And Immediate Execution. Safecap’s Online Trading System provide immediate transmission of Customer’s Order once Customer enters the notional amount and clicks “Buy/Sell.” This means that there is no opportunity to review the Order after clicking “Buy/Sell” and Market Orders cannot be cancelled. This feature may be different from other trading systems you have used. Customer should utilize the Demo Trading System to become familiar with the Online Trading System before actually trading online with Safecap. Customer acknowledges and agrees that by using Safecap’s Online Trading System, Customer agrees to the one-click system and accepts the risk of this immediate transmission feature. 13. Telephone Orders And Immediate Execution. Market Orders executed through the Safecap Trading Desk are completed when the Safecap telephone operator says “deal” or “done” following Customer’s placing of an Order. Upon such confirmation of the telephone operator, Customer has bought or sold and cannot cancel the Market Order. By placing Market Orders through the Safecap Trading Desk, Customer agrees to such immediate execution and accepts the risk of this immediate execution feature. 14. Safecap Is Not An Adviser Or A Fiduciary To Customer. Where Safecap provides generic market recommendations, such generic recommendations do not constitute a personal recommendation or investment advice and have not considered any of your personal circumstances or your investment objectives, nor is it an offer to buy or sell, or the solicitation of an offer to buy or sell, any Foreign Exchange Contracts or Cross Currency Contracts. 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Customer is aware of the risks inherent in trading CFDs and Spot FX Contracts and is financially able to bear such risks and withstand any losses incurred. 17. Customer May Not Be Able To Close Open Positions. Due to market conditions which may cause any unusual market price fluctuations, or other circumstances Safecap may be unable to close out Customer’s position at the price specified by Customer and Customer agrees that Safecap will bear no liability for a failure to do so. 18. Internet Trading. When Customer trades online (via the internet), Safecap shall not be liable for any claims, losses, damages, costs or expenses, caused, directly or indirectly, by any malfunction or failure of any transmission, communication system, computer facility or trading software, whether belonging to Safecap, Customer, any exchange or any settlement or clearing system. 19. Telephone Orders. 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These prevailing market prices will be the prices, which are ultimately reflected on the Customer statements. This may or may not adversely affect the Customer’s realized and unrealized gains and losses. 21. Compensation. Safecap participates in the Investor Compensation Fund for clients of Investment Firms regulated in the Republic of Cyprus. Customers will be entitled to compensation under the Investor Compensation Fund where we are unable to meet our duties and obligations arising from your claim. Any compensation provided to you by the Investor Compensation Fund shall not exceed twenty thousand Euro (20.000). This applies to your aggregate claims against us. TRADING POLICIES AND PROCEDURES 1. INTRODUCTION Safecap’s Trading Policies and Procedures are an integral part of your Customer Agreement. It is your responsibility to carefully read these Trading Policies and Procedures and to inform Safecap of any questions or objections that you may have regarding them before entering each and every Transaction. You agree, represent, warrant and certify that you understand and accept Safecap’s Trading Policies and Procedures, as set forth here and as may be amended from time to time by Safecap, in its sole discretion, and you agree to comply with Safecap’s Trading Policies and Procedures. Terms capitalized in these Trading Policies and Procedures are defined in the Glossary as found on Safecap website. 2. TRADING HOURS All references to Safecap’s hours of trading are in Greenwich Mean Time (“GMT”) using 24-hour format. Safecap normally provides access for trading CFDs and Spot FX Contracts via the Website from 21:00 GMT on Sunday to 21:00 GMT on Friday. Please refer to our “Instruments Table” for additional information. 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Where you place Orders with us, the execution factors that we consider and their relative importance is as set out below: 1. Price. The relative importance we attach is “high”. 2. Speed. The relative importance we attach is “high”. 3. Likelihood of execution and settlement. The relative importance we attach is “high”. 4. Size. The relative importance we attach is “high”. 2. We are the principal to every Order you place with us and therefore we are the only execution venue. 4. ORDERS 1. Orders Placement. All Orders must be placed through the Safecap Online Trading System or by telephone to the Safecap Trading Desk. Telephone Orders are accepted in the sole discretion of Safecap. 2. Types of Orders Accepted. Some of the types of Orders Safecap accepts include, but are not limited to: 1. Good till Canceled (“GTC”) - An Order (other than a Market Order), that by its terms is effective until filled or canceled by Customer. GTC Orders do not automatically cancel at the end of the Business Day on which they are placed. 2. Limit - An Order (other than a Market Order) to buy or sell the identified market at a specified price. A Limit Order to buy generally will be executed when the Ask Price equals or falls below the Bid Price that you specify in the Limit Order. A Limit Order to sell generally will be executed when the Bid Price equals or exceeds the As Price that you specify in the Limit Order. 3. Market - An Order to buy or sell the identified market at the current market price that Safecap provides either via the Online Trading System or over the telephone through one of the dealers. An Order to buy is executed at the current market Ask Price and an Order to sell is executed at the current market Bid Price. 4. One Cancels the Other (“OCO”)- An Order that is linked to another Order. If one of the Orders is executed, the other will be automatically cancelled. 5. Stop Loss - A Stop Loss Order is an instruction to buy or sell a market at a price which is worse than the opening price of an open position (or worse than the prevailing price when applying the Stop Loss Order to an already open position). It can be used to help protect against losses. Please note that because of market gapping, the best available price that may be achieved could be materially different to the price set on the Stop Loss Order and as such, Stop Loss Orders are not guaranteed to take effect at the price for which they are set. 6. Trailing Stop - A Trailing Stop is the same as a Stop Loss Order with the only difference being that, instead of setting a price at which the Order is activated, the Trailing Stop Order is activated at a fixed distance from the market price. For example, if Customer has purchased a long open position and the market Ask Price increases, the Trailing Stop price will also increase and will trail behind the market Ask Price at the fixed distance set by Customer. If the market Ask Price then decreases, the Trailing Stop price will remain fixed at its last position and if the market Ask Price reaches the Trailing Stop price, the Order will be executed. Please note that because of market gapping, the best available price that may be achieved could be materially different to the price set on the Trailing Stop Order and as such, Trailing Stop Orders are not guaranteed to take effect at the fixed distance for which they are set. 3. One Click Order Entry/One Click Execution of Market Orders. 1. Electronic Order entry for Market Orders equals Order execution. To enter an online Order, Customer must access the Markets window, then click on “BUY/SELL” for the relevant market. A new window will appear in which the Customer enters the price and lot size. The Order is filled shortly after the Customer hits the OK button provided the Customer has sufficient funds in his Account. Orders may fail for several reasons including changing dealer prices, insufficient margin, unspecified lot size or unanticipated technical difficulties. 2. One-Click Trading. To use one-click trading, Customer must go to the “Settings” menu and choose “View and Edit”. Customer should check the “One-Click Trading” box. To enter an online Order with one-click trading, the Customer must access the Markets window and enter the price and lot size. The Order is filled shortly after the Customer clicks the BUY/SELL button provided the Customer has sufficient funds in his Account. Orders may fail for several reasons including changing dealer prices, insufficient margin, unspecified lot size or unanticipated technical difficulties. One-Click Trading can also be used when closing positions. 3. Immediate Execution of Orders Through the Safecap Trading Desk. Orders executed over the telephone with the Safecap Trading Desk are completed when the Safecap telephone operator says “deal” or “done.” At that point Customer has bought or sold and cannot cancel the Order. When placing Orders through the Safecap Trading Desk, Customer acknowledges and agrees to such immediate execution and accepts the risk of trading in this way. 4. Order Cancellation. Non-Market Orders may be cancelled via the Safecap Online Trading System. However, there is no guarantee that Customer will be able to cancel an Order before it has been executed and Safecap shall have no liability for any claims, losses, damages, costs or expenses, including legal fees, arising directly or indirectly out of the failure of such Order to be cancelled. 4. Terms of Acceptance for Orders - It is Customer’s sole responsibility to clearly indicate the terms of an Order when entered, whether it is a Market Order, Limit Order, Stop Loss Order or any other type of Order, including the relevant price and lot size. Customer acknowledges and agrees that, despite our best efforts, the price at which execution occurs may be materially different to the price specified in your Order. This may result from sudden price movements in the underlying market that are beyond our control. Safecap shall have no liability for failure to execute Orders. Safecap shall have the right, but not the obligation, to reject any Order in whole or in part prior to execution, or to cancel any Order, where Customer’s Account contains Margin that is insufficient to support the entire Order or where such Order is illegal or otherwise improper. 5. Confirmation of Execution - Transactions executed online will be confirmed online in the Open Positions window and Deal Blotter in the dealing console, which is updated online as each Transaction is executed. Telephone Orders are confirmed orally and online in the Deal Blotter and Open Positions window immediately once the Order is executed. Confirmation of execution and statements of Accounts for Customer shall be deemed correct, conclusive and binding upon Customer if not objected to immediately by email if Orders were placed through Safecap’s Online Trading System or by telephone to the Safecap Trading Desk if Orders were placed by telephone, and such objection must be confirmed in writing within five (5) days after the day on which such objection was first raised. In cases where the prevailing market represents prices different from the prices posted by Safecap, Safecap will attempt, on a best efforts basis and in good faith, to execute Market Orders on or close to the prevailing market prices. This may or may not adversely affect Customer’s Realized and Unrealized Gains and Losses. 5. CUSTOMER ACCOUNTS AND INITIAL DEPOSITS 1. Documents. Before you can place an Order with Safecap, you must read and accept the Customer Agreement, including the Risk Disclosure Statement and these Trading Policies and Procedures and all applicable addenda, you must deposit sufficient clear funds in your Account and your Customer Registration Form and all accompanying documents must be approved by Safecap. Upon the approval of your registration, you will be notified by e-mail. Safecap may, in its sole discretion, request that in addition to online acceptance of the Customer Agreement, Customer must complete and submit any signed documents so required by Safecap, including but not limited to the Customer Agreement and Risk Disclosure Statement. 2. Currency of Accounts. All Account balances will be calculated and reported only in U.S. Dollars. 6. MARGIN REQUIREMENTS Customer shall provide and maintain Margin in accordance with the terms of the Customer Agreement to secure Customer’s obligations to Safecap. Margin includes Required Margin for Open Positions, which is based on (i) the Opening Margin Requirement; (ii) the Minimum Margin Requirement; (iii) the market value of Open Positions; and (iv) any additional amount as Safecap, in its sole discretion, believes is prudent to require. Customer must maintain the Minimum Margin Requirement on their Open Positions at all times. Safecap has the right to liquidate any or all Open Positions whenever the Minimum Margin Requirement is not maintained. 7. MARGIN CALLS Safecap maintains the right to liquidate Customer positions as set out above and is under no obligation to make calls for margin. However, Customer will receive an automatic margin call notification when logged in to the Online Trading System if the Account Equity in the Online Trading System equals to or falls below 100% of the minimum margin needed to open the position(s) held (the minimum margin needed to open position(s) is referred to in the Online Trading System as ‘Used Margin’). In addition, Safecap may contact Customer and request that Customer deposit additional Collateral to secure Customer’s obligations to Safecap. Any call for additional margin without exercising the rights to liquidate Customer positions shall not be deemed precedent for future calls act as a waiver of liquidation rights by Safecap. Safecap may allow the Customer to maintain Open Positions even if the Customer has not met one or more Margin payment which is/ are due, in Safecap’s sole discretion and upon approval by the Risk Committee. 8. LIQUIDATION LEVEL Subject to all additional rights of Safecap under the Customer Agreement, in the event that the liquid funds in the Customer Account should, at any time equal or fall below 20% of the Used Margin for Customer’s Account in the aggregate, Safecap will have the right but not the obligation to close any part of or all of Customer’s Open Positions. Any failure by Safecap to enforce its rights hereunder shall not be deemed as a waiver of such rights by Safecap. Safecap may contact the Customer via the means designated by the Customer to make a call for Margin in order to secure Customer’s obligations to Safecap but is not obliged to do so. Any call for Margin without exercising the rights to liquidate Customer positions shall not be deemed a precedent for future conduct and Safecap maintains the right to liquidate Customer Positions without calling Margin. 9. WITHDRAWALS Payments from a Customer Account require a withdrawal request form signed by all required account holders and submitted in writing to Safecap. The withdrawal process requires a minimum of three (3) Business Days from receipt of the withdrawal request to the issuance of payment. Safecap will transfer any funds owing to you to your nominated bank account. Only funds owing to you and not being utilized for margin purposes or any other obligations to Safecap may be withdrawn. If a withdrawal request is for funds in excess of those funds that are available for withdrawal, Safecap will not comply with the request and the Customer will be notified accordingly. I / WE HAVE READ, UNDERSTOOD AND AGREE TO THE RISK DISCLOSURE STATEMENT AND THE TRADING POLICIES AND PROCEDURES SET OUT ABOVE
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