The market’s fascination with the possibility that the Fed just committed a “policy error” has quickly morphed into a veritable obsession.
And it’s weird because it’s not like it wasn’t readily apparent prior to Wednesday that inflation was tepid and that the Fed was going to pull the trigger anyway.
Even if Wednesday’s CPI print hadn’t come in soft, there still would have been questions about whether inflation had truly turned a corner and virtually no one thought the Fed was going to lose its nerve and not hike.
So do we really know anything now that we didn’t know on Tuesday?
That’s not going to stop everyone from obsessing over it though, and admittedly, the collapsing yield curve is probably worth pounding the table on, especially now that the 2s10s has moved well below its 200-day moving average and looks to have a one-way ticket flatter:
Who knows, maybe once Percocet and cell phone plan inflation pick back up, it’ll all be fine:
Anyway, for those who are inclined to believe the Fed did not in fact fuck up, you might enjoy the following take from Bloomberg’s Cameron Crise, although we’d be remiss not to note that we don’t generally agree with it (especially not the part about how all you have to do to see that everything is fine is look at stocks and junk bonds).
But you know, in the interest of being “fair and balanced” and all that, here’s Crise’s note…
The recent rally in US fixed income seems to have awakened the chattering classes and prophets of doom. The Fed’s decision to tighten rates in the face of sluggish growth and limp inflation has encouraged a narrative that they are embarking on a policy error, with the flattening of the yield curve cited as a primary piece of evidence. Upon closer inspection, however, the prognostications of peril appear wide of the mark.
- If copper has a PhD in economics, then the yield curve must have a Nobel prize. There is probably no better financial indicator of the economic cycle than the slope of the Treasury curve.
- As such, the flattening of the past several months has garnered a considerable amount of attention. Does the 50 basis point flattening over the past six months herald an impending recession?
- I don’t think so, for a number of reasons. The curve usually has to invert to signal recession (the ultimate outcome of a hawkish policy error), and we’re a long way from that. In fact, my work suggests that the curve is exactly where it should be based on current monetary settings, using a 1996-2014 sample period. Moreover, we have the historical precedent of the second half of the 1990’s, when the curve was consistently flatter than current levels and the US economy did just fine, thank you very much.
- Moreover, it is difficult to argue that markets are pricing policy error when US stocks are close to all-time highs and have gone nearly a year without a 5% drawdown in the S&P 500. Meanwhile, high yield credit spreads are off of their lows but showing few signs of the type of widening that typically precedes recessions.
- Indeed, I was struck by an interesting development on Friday from Jeff Bezos, who is probably more responsible for low US inflation than any other single person. When Amazon announced a buyout of Whole Foods, they chose to pay with cash (presumably funded by debt) rather than stock, despite AMZN’s lofty share price. That says something about his view on the economic cycle…and he’s in a good position to know.
- When will the worm turn? When policy gets restrictive. Even gloomy economists think that the neutral real Fed funds rate is zero, which is still above where we are now. It’s true that the real funds rate has risen sharply this year, which possibly explains the soft patch in growth.
- But until the Fed takes rates restrictive into an environment of sluggish economic activity, I suspect that the real error will come from the oracles of awful output.