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Fed meeting was 'most boring of the year': Jefferies' David Zervos

Yahoo Finance’s Myles Udland, Julie Hyman, Brian Sozzi, and Julia La Roche speak with Jefferies Chief Market Strategist David Zervos about the Fed’s decision to keep rates near zero, and overall economic outlook.

Video Transcript

MYLES UDLAND: Fed wrapping up its year yesterday, announcing its latest policy statement, the latest summary of economic projections. We also heard from Fed Chair Jay Powell for the final time in 2020. And joining us now to talk all things economy, what the future of markets has in store for investors, is David Zervos. He's the chief market strategist over at Jefferies. We're also joined by Yahoo Finance's Julia La Roche.

And David, we have a lot of really interesting things to get to. I'd love to just begin by talking about yesterday's statement from the FOMC, what we heard from Jay Powell and how that changes anything that you were thinking about where the Fed fits in as we get into 2021.

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DAVID ZERVOS: Myles, doesn't change much for me. I think the meeting was probably the most boring meeting of the year, which is what I told our clients. I didn't expect the meeting to give us anything new. I know there were some people talking about twists and adding a few extra 10 years into the purchase program and the like.

Not something I was looking for. It's very hard to see the Fed even tinkering a little bit with things when financial conditions are in a really, really good place, equities are at record highs. It looks like many of the sectors that are interest rate sensitive are doing great. Those that aren't we expect to do better once the vaccine kicks in probably by Q2.

So I think, you know, the Fed just did a little victory lap. It was quick, it was easy, painless. The market might have had a little bit of disappointment for 30 seconds that they didn't buy a few extra 10-year notes, and then the 10-year note yield went right back down again. So I really don't think there was much new.

People are going to talk a little about, you know, the guidance being stronger. But we knew the guidance was strong anyway. They told us in the last few SEP projection forecasts they weren't really preparing for liftoff until at least 2023 and probably beyond. So I don't think there was any new news at all in the Fed's statement or the press conference.

JULIA LA ROCHE: Gotcha. So David, obviously your takeaway for clients is that it was a boring Fed meeting. But as we head into 2021, I am curious about how you're thinking about the markets in terms of, like, how you would structure the trade. I know one that we had talked about for a while was spoos and blues.

And I know back in March, we had a conversation around risk parity kind of entering the danger zone and then kind of shifting that trade. What is the trade structure for you today?

DAVID ZERVOS: Well, Julia, today we shifted in April and May away from short-end treasuries as our hedge because they rallied 150 basis points. So we were levering that part of the yield curve in a vol-adjusted way to hedge our equities, which is a classic risk parity trade. Once that yield structure in the Treasury market moved, we actually moved into IG, which worked out really well.

IG yields in the front end were north of 2%, even 2.5%. And those have come down to 1% now. So not only did our S&Ps work, but our hedge worked from March and April. So we've had a really good year in what I called spoos and sigs, sigs being short-term investment grade credit. That said, there's nothing left in investment grade credit now, so we're kind of stuck.

I think there's two choices for risk parity investors. One is a hedge in the currency markets for an event where we go risk off, which would be a tightening in financial conditions that's probably a mistake or unwanted, maybe a Fed mistake or an administration mistake or Congress mistake. That would send the dollar rallying, particularly against more the commodity type currencies, Aussie [? MECs ?] and the like.

So maybe you could have a long dollar hedge to a long S&P position. Or you just say, you know what? I got two great things next year. They both start with J, Jay Powell and Janet Yellen. And I just go with something like spoos and J's, and I don't really even have a hedge anymore because I know these guys have figured out their backstopping techniques.

Janet honed it during 2014 to 2018. And, you know, Jay's really come a long way from the 2018 fiascoes-- or yeah, 2018 fiascoes that really, at the end of the year, caused some problems for us. So I think Jay's in a good place for at least a year. He probably won't be the chair, in my opinion, next time around with a new administration.

But again, I think with Janet and Jay, you've almost got a hedge you don't need to pay anything for.

JULIE HYMAN: You forgot your J for jello, David, which you wrote about.

DAVID ZERVOS: Yeah, we could do that too.

JULIE HYMAN: You resurfaced a note that you had written about Janet Yellen years ago, which basically said it's time to party with her back in the driver's seat. But I am curious when you're looking ahead to what she's able to do, right, because you see a Congress right now that is really struggling to get stimulus done. So I'm curious what you expect from her in terms of getting the ball over the finish line or whatever bad sports analogy you want to use. What's she going to be able to do in that position?

DAVID ZERVOS: Look, I think Janet is eminently qualified to get in front of Congress, talk about the need for certain types of stimulus. I think the way the Democratic Party has couched stimulus is a little different than in the past. It's less about transfer payments and more about things like education, like health care, making sure we have a safe and smart environment in the United States and how those feedback into positive growth.

It's even less on infrastructure, which I'm quite positive to see that switch. I do think making sure those that don't have access to education and health care get it is a huge boom long run to growth for the US. So I think she's going to be a good-- she's just going to be a person that everyone can listen to and trust and doesn't come across as a hugely partisan person, even if she does have partisan tendencies.

And I think she will work very closely with the Fed. In fact, one may argue that the Treasury has a chance of silently even taking over the Fed with Janet in charge. I mean, she's very well-liked, very well-respected. And I think the relationship between the Treasury and Fed could be as symbiotic or even as close as it was before the Fed-Treasury Accord in 1951.

So you've got a Fed and Treasury with a combined balance sheet that could work together in the event of any kind of downturn to sort of get section 13(3) going quickly. There'll be no games like what Mnuchin was just playing with a few of the facilities in the last month. So I just think the backstop is very clear, and I think she'll be a good spokesperson for being sensible with fiscal policy.

And that's a positive, at least in my book. So I'm excited about it. Again, I don't think we know where the risk off comes from. We didn't know where it came from last year. Nobody had penciled in a virus, except for maybe a few people that were watching China closely. Maybe it's geopolitical, maybe it's something else along the health care lines, maybe-- who knows what it is.

But we get these bouts, and then we expect action. And I think we've got two people, Janet and Jay, who know how to deal with these unforeseen events very well. And that's a-- pretty much music to the ears of the risk asset markets.

MYLES UDLAND: All right, in the J's, we trust.