It took the Fed several long years to discover just how reflexive and circular the relationship it had established with the stock market had become. The Fed’s Catch-22 was first observed back in September 2013, when as the Fed was still debating whether to taper or not caught in a vicious cycle where any hint it would ultimately end QE would be met with a prompt selloff, Deutsche Bank explained how it had found itself in such a reflexive mess:
Another theme arising from their decision to hold fire was their worry that financial conditions had tightened over the past few weeks. If this is the case then the path of tapering is going to be tough because every time the market thinks they are going to taper, yields will likely rise and conditions will tighten. However the Fed’s guidance is becoming confused enough now that you couldn’t rule out another change of emphasis, especially as the composition of the Fed will change notably over the next few months. So markets are underpinned by liquidity for now but it’s a fluid situation and it strikes me that the Fed do not have a clear direction at the moment which makes them difficult to second guess.
Three years later, the Fed found itself in the same bind, eager to hike rates but very much unwilling to suffer the risk asset consequences this would entail, i.e., worried about a market selloff. And, as we discussed last October, in the Fed’s Minutes, for the first time we observed a Fed that appeared to have become self-aware, and had grasped just how reflexive the nature of its “communication strategy” with the market has been all along. To wit:
Over half a year later, we again go back to Deutsche Bank in general, and its most whimsical and metaphysical of strategists, Aleksandar Kocic, who first highlighted the reflexive nature of the Fed four years ago (and who recently has been more vocal on political topics such as the failure of globalization as the culprit behind Trump’s victory, and the backlash against populism), and who over the weekend extended the familiar circular frame established between the Fed and the market by one key player, layering in the the US presidency as a critical participant in the “communication channel” the Fed had established with the market. In other words, the “Fed put”, which Yellen et al financed “option by selling an (out of the money) option on their credibility” was being supplanted by a “Trump put.”