What happened yesterday during Jerome Powell’s press conference?
What accounts for the outsized market response to the Fed chair’s “transient” characterization of the factors weighing on inflation?
If you ask Nomura’s Charlie McElligott, the action “was certainly more a function of taking profits in recent ‘winners’ than a view that the Fed is actually pivoting, especially as STIRs continue to see scope for a Fed rate cut looking out 1 year.”
McElligott – who talked at length on Wednesday morning about the extent to which the market was likely to knee-jerk in a dovish direction in the event we got an IOER tweak – also notes that Powell “needed to lean hawkish on the margin in light of risks that the market could over-interpret the IOER ‘technical adjustment’ as a form of stealth easing.”
Ultimately, Charlie emphasizes that because disinflation appears to be structural (all efforts to continually ferret out plausible “idiosyncratic” factors aside), the Fed’s efforts to “slow-play” market participants’ easing expectations are likely to be frustrated by persistently sluggish upward price pressures.
Additionally, McElligott notes that the Fed’s “‘slow play’ on inflation while it heads lower only increases a future ‘asymmetric’ policy response coming-out of the Fed’s long-term review, and against a ‘stabilizing global growth’ framework.”
Although the street has, on balance, been more than willing to go along with Powell’s “transitory” narrative (probably because so many folks were caught completely wrong-footed with their Fed calls for 2019 and are now hoping against hope that a cut doesn’t materialize and make those calls seem even more off the mark in hindsight), Charlie isn’t afraid to call it like he sees it. To wit, from his Thursday missive:
Powell’s messaging on “transitory” factors behind inflation weakness (and “symmetry” of the target) was met with a collective eye-roll and broad investor cynicism: We have spent nearly the entire past 7 years below the Core PCE target, with the prior two “saves” (vs sharp deviations below target) being resolved by 1) the Shanghai Accord / Yellen “weak USD pivot” at start of ’16 and 2) by the US fiscal stimulus in late ’17—so I’d say the market remains “keen” on the Fed accelerating their “long-term inflation strategy review” conversations, especially after the upcoming the June symposium.
In other words, they’re going to have to change their inflation reaction function going forward, because there’s only so long “transitory” works as an adjective when the thing you’re describing (in this case inflation) continues to act in a way that isn’t in keeping with the way you (the Fed) thinks it “should” be acting.
As far as the allusion to the trimmed mean PCE, McElligott characterizes that as an effort to move the proverbial goalposts.
“Powell also sneakily ‘moved the goalpost a touch to help ‘look through’ the inflation weakness with regard to his referencing of the Dallas Fed 1Y Trimmed Mean PCE holding just below 2% ‘target’ (1.96) vs the current 1.6% Core PCE”, he writes, adding that this sleight of hand only adds to market skepticism.
Here’s a quote from Nomura’s Aichi Amemiya, who sums up one of the problems with Powell’s “transitory”s story:
He is trying to use the 2017 playbook, i.e., looking through a softening of inflation because it’s “transient.” Indeed, the recent slowdown in core PCE inflation was mostly attributable to non-cyclical components of core PCE price index such as drug prices. But, the real problem is that despite continuing tightening of labor markets, the contribution from cyclical components has not picked up over the past few years, which is different from 2017
McElligott then doubles (triples) down on the contention that Powell has now raised the odds of an dramatic reflationary policy maneuver later on down the road, whether that comes in the form of a change to the inflation framework, a decision to run the labor market “super-hot” or a 50bp cut (for example). “[This is] hilariously exactly what Powell’s colleagues have already been ‘trial-ballooning’ into the market universe over the past month”, Charlie quips.
As far as how to trade things, McElligott isn’t entirely on board with the notion that a rate cut from the Fed is a low-probability event, especially not relative to another hike. We’ll leave you with his comments on that:
As far as the “how do you trade this from here” punchline, I remain completely convinced that the bar to “CUT” is infinitely lower than the bar to “HIKE” again (thus, “asymmetric” ESPECIALLY as it relates to efforts to “Reflate”), but that this Fed “slow-playing” while US inflation trends lower (buying-time for their policy review) against the backdrop of actually stabilizing global growth (overnight we saw Taiwan GDP- and Korea Trade- data “better”) means we could actually see from here intermittent periods of tactical “bear-flattening” as Growth continues its recent re-pricing HIGHER vs occasional periods too of “bear-steepening,” as the combo of “stabilizing growth” aligns with 1) the Chinese Credit Impulse continuing and 2) the global CB discussion on “Reflation” escalating into the Summer.
Read full coverage of the Fed meeting and press conference