Deep Questions Rarely Have Surface-Level Answers

The pristine surface of a lake on a perfectly calm and sunny day is easy on the eyes. Yet it usually offers no insight as to what lies beneath. There is no indication of water depth, temperature, or aquatic flora and fauna in the glass-like surface, but instead a reflection of the surrounding land and sky – features that; while picturesque, have little to do with the inner workings of the lake’s ecosystem (see Figure 1). A curious passing hydrologist might be disappointed at this lack of surface-level information but would undoubtedly know to dive into the waters (or use high-tech equipment) to truly discover the secrets of the lake’s depths.

Figure 1: Mirror Lakes - Fiordland National Park, Milford Sound, New Zealand

Source: Photo by Navin Saigal, March 30, 2016

Similarly, the headlines around financial market events (especially in the post-pandemic economy) can sometimes conceal more than they reveal about the inner workings of the economy. In recent weeks, market participants have observed headlines of a “Payroll Miss” (June 4), an “Inflation Spike” (June 10) and a “Hawkish Fed” (June 16). However, the reality in the labor market is that there aren’t enough workers to fill vast quantities of open positions, resulting in slower than expected hiring (as opposed to a weak economy). Also, the inflation market is contending with used car price increases that account for much of the consumption basket’s gains (and are a result of temporary chip shortages in new car manufacturing), amidst historic base-effects against last year’s pandemic-driven trough in prices. Finally, the Federal Reserve (Fed) has done little more than recognize these realities and has suggested that the country is “on a path to a very strong labor market” (Chair Powell, June 16); commensurately making a modest tweak to the timing of expected rate hikes two years into the future. Interestingly, to imagine how dramatically things can change in two years, simply contrast one’s lifestyle in 2019 with the last 12 months. In each case, the simplistic headline masks a much more nuanced reality.

The Fed’s well-timed acknowledgement of eventual policy normalization is simply the next phase in a series of investment regimes that investors have had to navigate since the pandemic began last year (as we described in our recent piece Finding Some Real Perspective). The current investment regime, defined by the market pricing in more robust real growth potential, through higher real rates, started a few of months ago, but in some ways had been postponed, as the Fed waited to see evidence of that growth in the data. The Fed’s comments at its June meeting nonetheless created huge swings in market pricing (in duration, inflation breakevens, the U.S. dollar, and the growth and value factors, to name a few), especially in crowded positions that were designed to take advantage of a “dovish Fed,” rather than a “hawkish Fed,” (or the emoji equivalents, should they exist). While some of these reactions may have been justified, the reality of the Fed’s decision-making process is much more complex than can be described in a simple emoji, or most of today’s news headlines.