The Consequences of a Moving Target in Financial Markets
By John C. Simmons, CFA
Deputy Chief Investment Officer
February 13, 2023
Image Credit: "Governor Jerome Powell speaks at Brookings panel, 'Are there structural issues in U.S. bond markets?'" by BrookingsInst is licensed under CC BY-NC-ND 2.0. To view a copy of this license, visit https://creativecommons.org/licenses/by-nd-nc/2.0/jp/?ref=openverse.
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I love to include a baseball analogy whenever possible when I write about financial markets and investing. Sometimes it can be a stretch figuring out how to do it while remaining loyal to the topic at hand. Recent central bank developments make finding an appropriate baseball analogy easy this time around.
While Major League Baseball has outlawed the infield shift beginning in 2023, another type of shift is alive and well at the Fed. The focus of economic observers, market prognosticators, TV talking heads, and, yes, even the Fed has now flip-flopped completely from inflation to the jobs reports and employment data.
The concern here is not so much one of (the proper or most appropriate metric of) focus, but rather one of consistency and uncertainty. Uncertainty about what data the Fed is actually monitoring, emphasizing, and incorporating into its decision-making process. And if there’s one thing that the market doesn’t like, its uncertainty. Even bad news, when known with some degree of transparency and clarity, can be (at least somewhat) efficiently processed, integrated, and digested by the marketplace.
While (bad) news can result in down moves—sometimes violently so—market participants with an analytical eye and a firm grasp of risk and investment horizon can hedge (or altogether avoid) these speed bumps. In the case of longer-term investors, advantage can be taken of the resultant widened dislocations between price and value—and thereby more attractive opportunities—as appropriate.
A hurdle to the market’s mostly efficient existence is uncertainty, or, more accurately in this case, a moving target. At the very least, it adds a degree of volatility to price swings based on guesswork and the difficult interpretation of often muddled messaging and inconsistent statements.
The ironic development here isn’t so much that the Fed has seemingly moved the “goalposts of focus” (yes I did, in fact, used to be in a band called goalposts of focus…a story for another letter) from inflation to jobs, it is that this is consistent (but with the opposite goal in mind) of the Fed’s behavior for most of the past decade or more. Post-Global Financial Crisis, the Fed searched for almost any excuse it could find to continue on a path of ultra-easy monetary policy. From geopolitical concerns, to low-to-no inflation, to higher unemployment figures, to COVID, the Fed justified its dovish rate policy via the concern of the day, or the week, or the quarter. The fact that most of the developed world’s central banks followed suit only exacerbated this problem.
This “problem of the day” approach led to an incredibly difficult and extended period for fundamental investing (especially anything that was value-oriented) and an extraordinary amount of mal-investment and misallocation of resources. What this new “bizarro” approach could lead to is (again) another period where dexterous navigation is necessary and easily identifiable opportunities for outsized returns are hard to come by.
That said, the metric on which the Fed (and most others) now seem to be solely focused—the job numbers—are fraught with danger themselves. They are often adjusted after the fact, sometimes materially so, and their constituent makeup is much more complex than a simple headline figure that draws so much attention. Seasonality, part-time versus full-time, labor participation rates, unemployment rates, and “missing” workers are just some of the components and/or derivations that help build the mosaic of employment in the U.S. A deeper dive, analysis, and understanding isn’t for the faint of heart.
Despite this shift, our base case for the year remains consistent with market choppiness in the first half (accompanied by a shallow recession, at worst) followed by a market rebound in the second half of the year buoyed by reduced inflation figures and a (hopefully) more consistent focus by the Fed.