On Thursday evening, we brought you some highlights from SocGen’s revised Fed call which finds the bank’s Omair Sharif throwing in the towel on his previous call for two hikes in 2019.
To be sure, SocGen was already leaning on the dovish side compared to the rest of the Street and Sharif made it pretty clear after the January meeting that he no longer had much confidence. “Frankly, we walked away from today’s meeting and press conference thinking that the onus is now on the data to get the Fed to hike even once this year”, he said at the time.
Fast forward to Thursday and Sharif made it official. “We have revised our Fed call and are eliminating the two 25bps hikes we had penciled in this year”, he wrote, in a note called “Putting the Fed on hold”.
Well, in the interest of keeping readers apprised of the extent to which the Street continues to reassess the Fed path following January’s capitulatory lean (and continual speculation about the balance sheet, with the latest subtle hint coming from yet another Nick Timiraos trial balloon and a not-so-subtle hint emanating from Brainard on Thursday), it’s worth noting that Deutsche Bank’s Matthew Luzzetti and Peter Hooper have downgraded their Fed call as well.
“We now anticipate that the Fed will raise rates two more times this cycle in September 2019 and March 2020”, Deutsche’s US economics team wrote in a Thursday note, adding that the new call would leave the terminal rate at 2.875%, “down from [their] previous expectation of 3.125%.” They still expect one rate cut in 2021.
In the note, Luzzetti cites the deteriorating economic outlook across the pond, noting that DB’s European econ team now expects the region to “skirt close to a technical recession.”
As a reminder, Italy is already in a recession, and Germany dodged a downturn by the slimmest of margins in Q4, data out Thursday showed. Below is quarterly growth for Germany plotted with the broader euro-area.
As you can see, things are decelerating and all against a backdrop where the ECB has ended net asset purchases. On Friday, Coeure tipped a new round of TLTROs. That, we’ve variously argued, is all but inevitable – especially after the ECB acknowledged the downside risks last month.
On the domestic front, Deutsche cites slowing growth and, critically, the Fed’s new reaction function on inflation, which is a hot topic right now.
“The emphasis on ‘muted inflation pressures’ at the January FOMC meeting and a desire to see inflation move higher to re-start the tightening cycle has raised the bar for further hikes”, Luzzetti goes on to say, before noting that “greater tolerance of higher inflation also suggests that a more significant overshoot is required for the Fed to move firmly into restrictive territory and argues against three more hikes this cycle.” Dudley was on the tape Friday suggesting that a shift to the way the Fed thinks about inflation may be in the cards.
Given everything that’s going on right now from Washington to London to Beijing, and considering expectations that global growth is likely to decelerate, one might fairly ask why anyone (in this case Deutsche Bank) would think the Fed is going to raise rates again this cycle. One reason to believe this is a “pause” and not a “hard stop” is that financial conditions have snapped back after tightening materially in Q4. Arguably, one reason Powell stuck to the script and rode out the storm was down to a desire to curb risk taking by allowing the equity selloff to help tighten financial conditions late last year. Now, that dynamic has reversed (i.e., financial conditions have loosened) with credit spreads tightening (coming in) materially and stocks surging to their best start to a year since 1987. Additionally, there are good reasons to believe Washington and Beijing will ultimately call off the trade war at some point this year, although there’s an argument to be made that once that’s over, Trump will turn up the heat on car tariffs (more on that here). Finally, another government shutdown in the US has been averted, even if a national emergency declaration means the tension inside the Beltway is running even higher than it was before.
In short, all of that suggests things won’t fall completely apart and that in the event the growth backdrop stabilizes (albeit at a lower level), the Fed may be able to squeeze in another hike or two this cycle. That’s what Deutsche is sticking with as their baseline for now, anyway.
That said, the risks are myriad – the dangers clear and present. And on that note, we’ll leave you with one more excerpt from Luzzetti:
To be sure, the outlook is considerably more uncertain than usual. Further Fed tightening this cycle requires the dissipation of the various headwinds that are currently buffeting the outlook, including slowing global growth momentum, trade war tensions, Brexit, and domestic political issues, as well as some updrift in inflation pressures. A negative outcome on any of these fronts that spills over to domestic fundamentals would likely spell the end of the Fed’s tightening cycle.