Judging the Fed’s “emergency” rate cut simply on a snapshot of US equity benchmarks’ closing levels Tuesday probably doesn’t tell anything close to the whole story.
The simplistic read on things is that markets were spooked by Jerome Powell’s messaging, by the cut itself, or by both. But money markets had already priced in 50bps of cuts for March and speculation that the Fed would move prior to the scheduled meeting was rampant. So, it’s not entirely clear why anyone should have interpreted the timing or the size of the move as conveying a sense of urgency that was any greater than what the market was already expecting.
As far as Powell’s press conference… well, he’s not a good communicator. That’s one of the few things Donald Trump has been right about over the course of his presidency, which is ironic, because Powell was, of course, Trump’s pick.
Read more: Pop Your Collar, The Black Swan Is Here.
But we all know Powell isn’t adept when it comes to obfuscation (indeed, he describes his approach as “plain English”) and, as I’ve been pounding the table on for years, part of effective forward guidance involves a special kind of obfuscation, wherein the Fed listens to the market and the market listens to the Fed, in a two-way, running dialogue, wherein market participants are the co-author of the policy script.
In the Powell era, we’ve careened from one extreme to the other. In the beginning, Powell was the sole author of the script. That dead-ended in “long way from neutral” and a near bear market in Q4 2018. Then, in 2019, the market (and Donald Trump) effectively hijacked the entire policymaking process, taking it completely out of Powell’s hands, and forcing the Fed to move.
Now, in 2020, it’s not clear where we are, besides on the border of lost credibility.
“If anything, the next two weeks would likely have provided more information for the Fed make a policy decision”, Brown Brothers Harriman & Co.’s Win Thin said Tuesday evening. “This move smacks of panic, especially since there were no obvious signs of financial stability risks warranting an emergency action”. He added this rather amusing bit:
We believe the Fed should have remained calm and maintained its wait and see approach for now. It is simply too early to know how badly the US economy will be impacted by the virus. Instead, the Fed cut validated market expectations. In fact, the market is like a typical junkie and now wants even more as it is pricing in a total 125 bp of easing compared to 100 bp prior to today’s cut. If the Fed were to cut rates that aggressively, then it would not have any ammo to address a situation in which monetary policy could actually have an impact on the economy.
Others were similarly skeptical.
“At this pace the Fed will be back at the zero bound in June, rather than September”, Rabobank’s Philip Marey (who has long maintained the Fed would cut rates back to zero) remarked. “Today’s action may have backfired and started a feedback loop reinforcing the Fed’s freefall to the zero bound”.
Indeed it might, Philip. That was the risk, and that’s precisely what happens when you feed a “junkie” (to quote the above-mentioned Win Thin).
Ryan Sweet, from Moody’s, called the move “rare and risky” given that it could reasonably be construed as the Fed going into panic mode. “The Federal Reserve needed to step in. However, monetary policy isn’t a panacea”, he wrote, in a note, adding that the real goal should be to ensure credit markets don’t freeze up. (There’s more on the latest from credit land here).
AxiCorp’s Stephen Innes was a bit more kind. “Fear is the economic problem, and Twitter is the super spreader”, he said Tuesday, in an assessment that I personally agree with wholeheartedly. I’ve written voluminously in these pages about the extent to which fear has been “elevated to a new heuristic” in the post-crisis world (to quote Deutsche Bank’s Aleksandar Kocic).
“We know central banks cannot directly reverse that, nor can they force people into shopping malls or onto planes”, Innes went on to say, adding that while “the debate will rage on about the merit of the rate cut… from my perspective, the swift and decisive move was a necessary measure to support the equity markets which were entering a death spiral and demanded an urgent response”.
JonesTrading’s Mike O’Rourke was characteristically straightforward. “[Monday’s] rally put Chairman Powell ahead at the tables and he was playing with house money when it came to a policy response”, O’Rourke said, in a Tuesday evening note. “Today, he pushed all in and likely made a major policy mistake in doing so”.
The problem is that the virus headlines are highly likely to get worse from here, which means policymakers really should conserve scarce ammo. Of course, that’s exceedingly hard to do when rates traders keep pressing their bets and making it appear as though policy is further and further behind the curve.
In any case, Powell has a problem. “The slowdown related to the coronavirus is only just commencing [and] the negative headlines will continue for weeks, if not months”, O’Rourke laments. “That is an engraved invitation to portfolio managers to sell and de-risk their portfolios”.
As of last Tuesday (i.e., the period covered by the latest CFTC data), asset managers still had a lot to sell and de-risk, even after the purge highlighted in red/yellow in the visual.
On the bright side for equity longs, futures were pleased with early Super Tuesday results, which found Joe Biden turning in what, by most indications, was a strong showing.
Sanders will likely make up some ground in states with polls closing later, but there does seem to be some merit to campaign watchers’ contention that South Carolina marked a turning point for Biden, and that endorsements from Pete Buttigieg and Amy Klobuchar provided a meaningful boost to the former VP who, just a month ago, was on the proverbial ropes.