When Doves Fry: Why A Fed Pivot Is ‘Wishful Thinking’

“I think it’s a good tale on some level for story books, but it’s not driving how I’m thinking about policy,” Raphael Bostic told MarketWatch this week, in an effort to dispel the notion that his recent comments on a prospective Fed “pause” in September were an attempt to reinstate the vaunted policy “put.”

Bostic’s “pause” remark was credited for catalyzing the best week for US equities since November of 2020. It certainly didn’t hurt, but month-end rebalancing flows were in play, and as I put it ahead of the bounce, oversold markets have a way of rebounding “just because,” especially when positioning is light.

Although it’s certainly possible the Fed would consider taking a break from hiking rates in September depending on the circumstances, the macro environment is the very definition of “fluid.” It’s impossible to say what might happen next week, let alone next month, and pervasive pipeline inflation means any sustainable relief in consumer prices will either come at the expense of corporate profits or not at all.

To Nomura’s Charlie McElligott, the Bostic “pause” story remains “wishful thinking” on the part of market participants who, try as they may, can’t quite shake their post-GFC Pavlovian response function.

“Markets are using old muscle memory of prior Fed episodes over the past decade to try and time a ‘dovish pivot,’ but it’s just too early for that,” he said, noting that “the math behind getting inflation down to 2% simply isn’t there yet.”

Importantly, a pause in September would need to be telegraphed at Jackson Hole and absent some extraordinarily fortuitous turn of events, would almost surely be a “water break” (if you will) on the way to more hikes. The midterm elections are on November 8. If the Fed pauses in September, and inflation remains well above target (which it will), they’ll have to hike just days ahead of the polls.

It’s very difficult to envision a scenario where two consecutive pauses would be warranted given inflation realities, so assuming the Fed wants to take a “polite” pause for American democracy (whatever’s left of it), it’d make more sense to hike 25bps in September and take November off, especially given December is an SEP meeting.

“In the unlikely case there actually is a pause it’d be just that — a temporary stop to push back on a disruptive FCI response and not the end of tightening required to bleed demand,” McElligott said. In other words, any prospective break wouldn’t constitute a “dovish pivot.”

For Charlie, there are myriad reasons to believe Fed hawkishness, truncated forward guidance and, as a consequence, elevated rates vol, will remain a fixture of markets for the foreseeable future.

He reminded traders that what we’ve seen over the past several weeks in terms of pressure on stocks, cooler housing market data and a string of misses from regional Fed surveys, is precisely what policymakers want. It’s “what the Fed needs to pinch demand, so you don’t stop prematurely, especially as we’ve yet to see a credible explanation for just how the Fed gets back to a 2% inflation target with jobs still printing 400k+ a month and with the Atlanta Fed Wage Growth Tracker printing 6% and at all-time highs,” he wrote.

Note the sky-high rates for job switchers in the figure (above).

This is why good news remains bad news — why the market wasn’t particularly amused with May’s hotter-than-expected ISM manufacturing survey, for example, and why any evidence of even hotter wage growth accompanying Friday’s jobs report would likewise be greeted with consternation, especially in the context of the latest JOLTS data, which showed no progress.

And that’s not all. There’s also the potential for vol spillover from abroad as a trapped ECB ponders a 50bps hike, an idea that would’ve been laughed out of the room a mere six months ago. Now, it seems at least plausible (if still out-of-consensus) considering the wild juxtaposition illustrated in the figure (below).

Forgive me, but does anyone know what’s going to happen if the ECB, an institution which, prior the pandemic, was destined to join the Bank of Japan in deflationary purgatory, is suddenly compelled to hike rates out of negative territory in 50bps increments? The answer is “no.” No one knows what the ripple effects of that might be, especially considering the famously distorted nature of the euro fixed income market, which will also need to cope with the cessation of net asset purchases.

Panning back out, crude is near 2022 highs, even as the Saudis are apparently willing to pump more oil to avoid losing control of prices as Russian barrels become contraband. That’s inflationary, and as McElligott observed, the US now has “little SPR optionality” left, which “gives real delta to a left-tail trade.”

Speaking of left-tail trades, Charlie also noted that QT is commencing. That matters. “Less cash to absorb more collateral will impact repo rates and bleed into spread product,” he said.

The bottom line, McElligott wrote, is that although “there is a scenario in Q4 where we do see the Fed downshift from 50s to 25s, we aren’t there yet, and until we see core PCE begin to dip sustainably below 4% into the mid-3s,” 50bps it’ll probably be.