If you asked Nomura’s Charlie McElligott ahead of the March FOMC, there was scope for the selloff in rates to persist irrespective of what the dots did (or didn’t) reveal.
The market’s dot-obsession bordered on the absurd headed into the meeting. The dots arguably create an extremely unhealthy dynamic. Every three months, policymakers effectively tease the market by releasing a chart depicting individual guesstimates of the price of money years in advance. Sometimes, Fed officials will tacitly (and ludicrously) suggest that nobody should take the dots seriously. “Ludicrous” because these are the same people who decide what the price of money will be. How can they possibly expect market participants to ignore such a thing?
Anyway, McElligott acknowledged the “enormity” of the March Fed dot release, noting that Wednesday will “determine the next phase of the current status quo ‘reflation’ trade.”
He reiterated that the Fed might be “best served by acknowledging the inevitability” of the situation, which just means marking the dots to market, so to speak, in order to resolve what’s become a truly tense standoff. Everyone is aware that policymakers (both on the fiscal and monetary side) intend to let the US economy run hot. That’s not going to change just because the median dot two years out moves up.
Ultimately, the new dot plot found more officials expecting tighter policy sometime in the next two years, but the median still showed rates at the lower bound through 2023.
The market, McElligott wrote prior to the reveal, was simply “pricing the realities of growth normalization and an inflation impulse.” There was probably more than a little utility in catching up to that pricing now, rather than waiting. Because as the market moves further away from the Fed (on the assumed success of vaccine rollout and the likely economic impact of stimulus being spent into a suddenly reopen services sector) closing that gap at future meetings risks sending two disconcerting messages at once:
- It would be an admission that the Committee was behind the curve previously (where “previously” means right now, in March). That would raise uncomfortable questions about whether the Fed would, in fact, be successful in tamping down inflation should it start to run away from them too. That is: It would be seen by those who are currently fretting about price pressures as evidence that the Fed is destined to be too late to curb a sharp rise in inflation.
- It would risk sending an “overtightening” message, even as everyone would recognize that officials were simply filling the gap. Think about it this way: It’s easier to lay a plank over a creek than it is to build a bridge over a mile-wide ravine. It’s also less dangerous.
No matter what the dots showed, McElligott reckoned the market would “press the bear steepening move until the Fed acknowledges a more substantive set of tightening criteria.”
Of course, the Fed is loath to do that, preferring instead to insist that the current forward guidance on rates and asset purchases is as specific as it can be without handing out Eccles-themed calendars with dates circled in red Sharpie. The Fed is implicitly asking the market to solder the dots to the existing outcome-based language and consider that date- and state-dependent forward guidance.
With Powell making only passing allusions to WAM extension and merely reiterating the Committee’s readiness to deploy “all of our tools,” the market may look to press the issue in the bear steepener. Depending on the rapidity of any such move, equities could suffer some indigestion (again).
For McElligott, that could be exacerbated in the short-term by the scope for freer movement (in equities) once the gamma pin losses some of its pull. “It’s entirely possible… that we do get a big ‘de-risking’ as enormous Gamma and Delta roll off following the quarterly options expiration,” he said Wednesday. “Those dealer hedging market buffers [will] disappear, exposing markets to a much wider distribution of outcomes thereafter, especially [if] the Fed acknowledges tightening at a date closer to ‘now’ than previously estimated.”
Although no headline will say the Fed “acknowledged” tightening may be coming sooner, seven officials now have dots higher than zero for 2023 versus just five in December. The numbers are four versus one for 2022.
Note that “closer” and “tightening” are highly relative terms, which means that once any post-Fed shenanigans shake out, and any post-Op-Ex volatility comes and goes, the market would be free to again focus on the same set of upbeat macro drivers, from vaccines to reopening.
“My anticipated equities sequencing ultimately sees any post Fed- and Op-Ex dip being bought,” Charlie said Wednesday. “Especially with spring reopening ‘animal spirits’ likely seeing economic data… accelerat[e] on pent-up demand and base effects, in conjunction with already bullish seasonality into April and May.”
And don’t forget about “stimmy.” There’s always the “stimmy.”