Self-described “truth fan” Jeff Gundlach knows what’s up.
“It took less than 2 days for the bond market to nullify the Fed’s ‘we’re firmly on hold’ message this week”, Gundlach tweeted, in what I’m sure he believes was a profound observation. “Now a 90% chance of a 2020 cut”.
It wasn’t clear whether those were subjective odds or whether he was looking at actual market pricing, but whatever the case, Jeff’s pronouncement made actual news. Bloomberg ran a story containing two sentences and a screencap of his tweet.
We mention that as a comedic anecdote. Regular readers know we’ve long had a bit of fun at Gundlach’s expense, and certainly not because we don’t acknowledge his success. Rather, Jeff’s penchant for stating the obvious in terms that suggest he not only wants you to believe he’s the first person to have thought of something that is apparent to everyone, but that he in fact believes as much himself, is objectively funny.
The Fed is, of course, in the middle of a policy review that’s expected to yield (get it?) a shift in their approach to inflation. During his press conference on Wednesday, Powell was reasonably adept at navigating what could have been a tricky question around a tweak to the inflation language in the statement, which echoed concerns from the December minutes.
But it would be too much to say he was “successful”. He did seemingly underscore the notion that the bar for more rate cuts is very low, and that the Fed is determined to do what it takes (including tolerating overshoots) in order to get inflation sustainably to target.
And while real yields apparently “believe” the part of the messaging about the Fed’s willingness to try, breakevens plainly don’t think the Fed will succeed, even if they do manage to keep the economy afloat and stocks buoyant.
Without tying myself in rhetorical knots trying to disentangle what counts as communications “success”, suffice to say that real yields and breakevens both tumbled in January, which suggests market participants believe policy will probably take another dovish turn, but it ultimately won’t matter for inflation.
Of course, it’s not just doubts over the Fed’s capacity to engineer outcomes that are weighing on breakevens. Oil has plunged amid the virus-related global growth scare, which is itself feeding expectations for Fed cuts.
The relationship between crude and inflation expectations is everywhere and always something of a chicken-egg problem, but the bottom line is that between 10-year breakevens falling in January and nominal 30-year yields pushing below the Fed’s inflation target (with a little help from a convexity-flow-related pile-on), it’s safe to say the bond market is, for now, signaling virtually no faith in the notion that more rate cuts or the policy review will change the game in terms of countering structural disinflationary dynamics.
Against this backdrop, the Fed will almost surely have to cut at some point in 2020, barring a convincing inflection in growth expectations globally and/or an out-of-the-blue spike in inflation at home.
After all, if the Wuhan virus (or any other macro antagonist) short-circuits the nascent ex-US recovery that started to get priced into bonds in Q4, it’s entirely likely that a still-resilient US economy will lead to persistent dollar strength and thereby chance more imported disinflation.
“As a thought experiment, it strikes us that the announcement of average inflation targeting would be unconvincing in the presence of an inverted curve and very low breakevens, all the more so if the ‘exclamation point’ for the strategic review were almost anything other than a rate cut”, Deutsche Bank wrote Thursday.
“The expected shift in framework, and hence shift in optimal policy setting, is part of the reason we continue to look for an easing announced alongside the change in framework in June”, JPMorgan’s Michael Feroli remarked this week.
So, coming full circle, Jeff Gundlach is probably correct. There is a very good chance of a Fed cut in 2020.
But that’s hardly a unique observation.