If Jerome Powell intends to roll back the “mid-cycle adjustment” characterization of the July rate cut and its likely September sequel, his colleagues didn’t do him any favors ahead of his hotly-anticipated remarks from Jackson Hole on Friday.
Eric Rosengren on Monday said he wants to see concrete evidence that something’s gone awry before he supports any rate cut, Esther George on Thursday reiterated that the July cut “wasn’t required”, Patrick Harker said he only “reluctantly” backed last month’s decision and then, to top it off, Robert Kaplan told CNBC on Thursday afternoon that the Fed should be cautious about cutting rates again “unless we have to”.
Throw in the July FOMC minutes which suggested a somewhat broad consensus around the idea that a full-on easing cycle isn’t necessary (the account of the meeting showed most officials concurred with the characterization of the cut as a “mid-cycle adjustment”), and you’re left to ponder the distinct possibility that Powell may deliver a similarly “hawkish” message, despite (or perhaps because of) a month’s worth of market tumult and Trump tweets.
Note we said “because of”. It seems at least possible that the Fed has now reached the limit when it comes to allowing the tail to wag the dog, whether that means letting the bond market pigeonhole the committee into dovishness or permitting the White House to bulldog them into preemptive rate cuts.
And really, that’s all part and parcel of the same dynamic. Larry Kudlow and Peter Navarro have repeatedly said “the market” agrees with the administration on the need for rate cuts, which suggests Trump is aware that by creating uncertainty around trade, he can force the type of market positioning that makes it difficult for the Fed to disappoint expectations without tightening financial conditions, something they are reluctant to do.
It may be the Fed has decided that with a September cut already baked in, there is no utility in relenting to demands (implicit or explicit) for the telegraphing of a full-on easing cycle.
If Powell does intend to send a message to the bond market and to Trump on Friday, he’s probably aware that there will be consequences. In addition to any tweets that would accompany an adverse equity market reaction, the bond market will need to adjust. That could entail significant flattening pressure as the short-end prices in fewer cuts and the long-end rallies (or stands still) on the assumption that the Fed is further behind the curve when it comes to doing what’s necessary to protect growth and resurrect inflation.
Breakevens have plummeted ~20bps from the July meeting, conveying “substantial skepticism” about the prospects of the Fed achieving its mandate, BMO noted on Thursday.
Meanwhile, the dollar continues to be resilient, and 2-year yields rose on Thursday to the highest in more than a week.
With inflation expectations in a dive, term premia spillovers in full effect and investors more inclined to turn to Treasurys as a hedge than ever before, this is a perilous time for Powell to risk pushing back against the market, which is convinced it’s made its point when it comes to compelling an abandonment of the “mid-cycle adjustment” story.
Against that backdrop, a hawkish message from Powell runs the risk of amplifying Rosengren, George and Harker, on the way to creating more flattening pressure, unwanted dollar strength and, likely, significant equity market volatility.
Surely he wouldn’t risk it – or would he?