McElligott On The Fed’s ‘Line In The Sand’

On Wednesday, hours prior to the June dot plot reveal, Nomura’s Charlie McElligott wrote that “Powell will do more of the standard ‘both sides of mouth’ messaging.”

And he did. The post-meeting press conference was a clinic in just that type of messaging.

I would note that Powell’s penchant for “plain English” means he has a harder time obscuring contradictions compared to the kind of opaque, academic doublespeak that only PhD economists are fluent in. In simple terms, Powell sometimes makes statements that cast considerable doubt on policymaker omnipotence (e.g., “[Inflation] could turn out to be higher and more persistent than we expect”). Everyone lampoons economists for masquerading as real scientists, but when push comes to shove, nobody really wants to hear “We just don’t know.” When it comes to central bank communications at post-meeting press conferences, academic doublespeak is like a golf tournament on a Sunday afternoon — pleasantly boring and conducive to napping.

By contrast, Powell’s sometimes blunt cadence (and refusal to sit down) injects unnecessary tension into the proceedings, even as he’s a generally likable personality (as far as private equity guys-turned central bankers go, anyway).

In a Thursday note, Nomura’s McElligott cited the “usual dovish caveats” Powell delivered, including the Fed Chair’s almost derisive characterization of the dots as bad forecasters that “should be taken with a big grain of salt.”

Still, McElligott said “the overall FOMC message was a ‘line in the sand’ hawkish inflection.” It’s clear, he said, that the Committee’s confidence in the “transitory” talking point was shaken by inflation beats in both April and May. Policymakers, Charlie suggested, are “seemingly… concerned about heightened ‘stickiness’ of supply-chain disruptions,” which Powell fretted may last longer than the Fed initially believed.

Crucially, Charlie said that the Fed’s decision calculus may have shifted from relying almost solely on tapering “as the primary weapon” for tightening to a situation “where hastened rate hikes will be a much more meaningful part of the ‘accommodation removal process.'”

That raises questions about what might happen if one (or even two) of those ~1 million NFP prints which have thus far been elusive were to come calling, especially with the phasing out of enhanced unemployment benefits.

Ultimately, McElligott suggested that the Fed may struggle to reconcile the dots with average inflation targeting.

The problem here is rather glaring. Implicit in almost all of the Fedspeak was the notion that it would take a lot more than a few hot inflation prints to make the Committee blink, especially given the myriad distortions still plaguing the data. And yet, the dots show quite a few officials have already blinked, and we’re not even clear of the base effects yet, let alone the supply chain bottlenecks.

For anyone apprised of how “it all works” (if you will), the risk here is obvious. If real yields surge (figure below), bolstering the dollar and pressuring breakevens lower, the read-through isn’t great for risk assets because, after all, what do higher reals and a stronger dollar scream? They scream: “Tighter financial conditions!”

McElligott underscored as much, writing that, “this is an impulse blast of tighter US financial conditions which can, if sustained, endanger risky-assets, particularly commodities [and] inflation-sensitives like metals, but just general ‘high yield,’ carry-type EMFX too.”

Commodities were poised for their worst weekly performance since the onset of the pandemic (figure below). The dollar jumped, and breakevens touched the lowest since February 26.

“We’ve made this observation in the past and will argue it continues to hold – as long as financial conditions are sufficiently easy, the Fed will lay the groundwork for tapering and eventually follow through,” BMO’s Ian Lyngen and Ben Jeffery said Thursday. “Policymakers are not in such a hurry to scale back bond-buying as to risk an inadvertent tightening of financial conditions, although all else being equal, edging back from the uber-accommodative current stance is without question on the Fed’s agenda as the real economy recovers and the fallout from the pandemic begins to fade.”

For McElligott, the lack of a significant selloff in stocks post-hawkish pivot isn’t an example of equities being somehow pleased with the prospect that eventually, policy will be normalized.

“I can get down with that view [from] a structural, long-term philosophical argument that ‘The Fed is killing markets through their micro-management of financial conditions’ perspective,” Charlie said, but warned that “people are confusing correlation with causation.”

It’s wrong, McElligott warned, to say that “equities are stable on hawkish Fed guidance.”

Rather, stocks “are stable for the same reason they’ve been chopping for weeks,” Charlie remarked. “Markets continue choking on an oversupply of Gamma from Vol sellers.”