Admittedly, I found it difficult to get totally behind the notion that the June FOMC marked some kind of watershed moment.
Jerome Powell certainly didn’t describe it that way. In fact, he came pretty close to calling the dot plot useless, which it most assuredly is. It’s impossible to forecast economic outcomes years into the future. Doing that and then extrapolating (from your forecasts) the appropriate price of money two and three years hence is mostly a waste of time. A diagram of those extrapolations has virtually no practical value.
Besides that, consider this: There is no sense (none) in which the policy conjuncture would be “hawkish” even after a full taper and two rate hikes. Such a conjuncture would still leave rates at historic lows and the Fed’s balance sheet bloated beyond recognition even in the post-financial crisis context. We can’t even see 2010-2019 “normal” from where we are now (on the balance sheet, anyway) and it’s safe to say we’ll never see pre-GFC “normal” again (figure below).
For me anyway, the idea that the “party is over” or that the proverbial “punchbowl” is being “pulled” because Fed officials think they might hike rates 50bps when we’re all two years older than we are today, seems asinine.
But look, I don’t want anyone (including and especially analysts and journalists) to think I’m somehow ignorant of the circumstances. I have a tendency to be crudely reductive — putting things in perspective is one thing, but I sometimes trivialize things completely, a penchant I’ll chalk up to living in isolation. The vastness of the ocean (and the oddly intimidating sounds it emits when there’s nothing else stirring in the morning) has a way of making conversations about a few hypothetical basis points on the funds rate seem wildly trivial and ridiculously pedantic.
Sometimes, the only way I can rationalize granular analysis of something like the dot plot is to remind myself that the price of money in the US has an absurdly disproportionate ripple effect. Fed policy can drive entire countries to the brink of economic calamity and some swear the US might soon be one of those countries.
Anyway, the 5s30s narrowed to a YTD low of 128bps on Thursday in the wake of what we’re calling a dramatic Fed pivot (figure below).
In a testament to the ramifications of any perceived turn in Fed officials’ disposition, emerging markets felt some pressure. For example, South African yields rose the most in months and color which may have otherwise touted ruble appreciation following Joe Biden’s “constructive” chat with Vladimir Putin instead said things like (from Bloomberg), “The ruble was little changed as speculation about US interest rate hikes outweigh[ed] optimism for the Russian currency after Wednesday’s summit between presidents Putin and Biden.”
“In response to [Wednesday’s FOMC], we have maintained our baseline view on the timeline for a tapering announcement, expecting a signal later this summer and an official announcement by year-end [but the] hawkish shift raises the risks of the announcement coming somewhat earlier, particularly if inflation and inflation expectations surprise further to the upside in the coming months,” Deutsche Bank’s Matthew Luzzetti said. “Given new information from the dot plot about the Committee’s reaction function in the context of its Flexible Average Inflation Targeting framework, we have brought forward liftoff from Q2 2024 to Q3 2023.”
“In our view, the more hawkish projected policy path likely reflects a backward-looking interpretation of average inflation targeting, since inflation will likely have averaged over 2% by the time tapering is complete if the Committee looks back to either the announcement of the new framework or the start of the pandemic recession,” Goldman’s Jan Hatzius wrote.
“Oh ye of little FAIT! We are still talking about no rate hike for two and a half years, most probably and there won’t be any tapering of the $120 billion of QE a month until ‘substantial further progress’ has been made toward the Fed’s maximum employment and price stability goals,” Rabobank’s Michael Every wrote, before noting that we still don’t know what “substantial further progress” means.
“For almost a year the Fed said it would use FAIT to help fight unemployment of minority groups, which tend to get last hired and first fired,” Rabo’s Philip Marey said, in his own post-Fed remarks. “However, a few unexpected data points and they are the first to be sacrificed by the social justice warriors with the wobbly knees.”
Enjoyed that. Deep down I’m not sure if the Fed will actually get around to hiking by 2023, but this ‘pivot’ could easily drive a narrative shift that financial conditions will tighten over the ‘macro’ horizon, which might be enough to send the USD and 5yr real yields higher (at -150bps, they have a long way to go before they become problematic in my view).
I completely agree with you here. A central bank policymaker on the BOE once described monetary policy as an iterative process. He then fleshed out the fact that they make a decision, and then see what happens and then course correct. It looks like a reduction in asset purchases of UST bonds may start sometime in the next 6-12 months. That was tipped maybe a little by ending and unwinding the corporate bond and ETF purchase program by the end of this year. But the FOMC has a lot of flexibility here. If the economy is better than forecast they may start in December or January and probably reduce purchases faster. If it is worse, perhaps they wait for the sun to come out and then unwind at a much slower rate. As for lift-off from the zero bound- same thing. It is weather dependent. Maybe it happens in mid-2023, maybe a bit sooner or maybe later. The process is iterative. The Fed is going to be a price taker here and will react to current circumstances- that is the point of average inflation targeting. It is probably more important to try to figure out where fiscal policy is going and where the overall economy is going rather than go in circles about the FOMC.
It seemed to me that the Fed’s message was ‘our eyes and options are open’. They aren’t dismissing price increases, but don’t see excessive inflation. They aren’t ready to taper or raise, but are keeping both on the table for the outyears. They are going to wait and watch, but will give the markets ample notice of any moves. About as benign as one could want. Could be more benign, but you wouldn’t want that as the headlines would then be ‘Fed to let inflation run out of control.’