“The markets have become addicted to Fed forward guidance and assume that the Fed is in control of the markets. I believe this trust in the Fed will be disappointed and transform into a destabilising force,” he says. Klement notes that markets are extremely nervous, since mere announcements of a change in monetary policy in the future cause strong market reactions these days. “In the past markets responded only once interest rates had changed.”
Moreover, the “horrible track record” of the Fed when it comes to predicting macroeconomic data does not bode well for the future either, Klement believes. “The moment the economic data deviates from the expectation of the Fed and the market, the discussion changing the speed of tightening will start. This will lead to heightened uncertainty, which in turn is bad for stock markets.”
The slow pace of a rate increase the Fed has promised will also contribute to uncertainty in the long run, Klement believes. “With its commitment to a slow rate hike the Fed effectively prolongs and increases the period of uncertainty that is associated with a shift in monetary policy, effectively destabilizing stock markets.”
“So all in all I believe that forward guidance is a fool’s errand that in the long run effectively creates the very uncertainty that it tries to reduce,” Klement concludes. Considering the above, it’s not surprising Klement is currently underweight US equities. “And once the Fed starts hiking we will be on code orange for a further downgrade.”
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