“It ain’t over ’til the Fed lady sings,” BofA’s Michael Hartnett wrote, employing a somewhat tortured version of an exhausted colloquialism in the latest installment of his popular weekly “Flow Show” series.
His point, obviously, was that the pain for stocks likely isn’t over. Not with the Fed still hammering home the notion that the Committee plans to push rates into restrictive territory even at the cost of lost economic momentum.
“Bear markets end with a recession or an event that causes the Fed to reverse policy,” Hartnett said. In his view, 2022’s bear market is merely on “summer hiatus.” It “ain’t over,” he warned, adding that it may be “too early” to price in a sharp reversal from the Fed in 2023.
Last week, as recession fears grew, traders priced in a trio of rate cuts for next year (figure above) on the assumption that if the US is already on the brink of a downturn with just 150bps of tightening delivered, another 200bps of tightening will surely “drive this economy off a cliff,” as Elizabeth Warren put it last month, while cautioning Jerome Powell against being overzealous.
Why too early? That is, why shouldn’t the market preemptively price a Fed pivot when it’s all but a foregone conclusion that one way or another, the US economy will succumb over the next 12 months?
Well, simple. Because the math is very challenging for the Fed’s year-end 2023 PCE projection. Specifically, the Committee needs monthly prints of 0.2% or lower (figure below, from BofA).
Anything beyond that leaves PCE inflation at least one full percentage point above the SEP forecast for next year. Again, that’s just to get to 2.6%. Getting to 2% is even more far-fetched.
At the same time, central banks are in the unenviable position of having to take sole responsibility for a problem they weren’t alone in creating. Inflation isn’t the White House’s mandate. Nor is Congress compelled to answer for price stability. And yet, the supply factors which account for more than half of America’s inflation problem require political solutions, not demand destruction engineered by way of rate hikes.
But those political solutions must be actual, long-term solutions, not stopgap measures that carry a high risk of backfiring. Unfortunately, that’s all there is in the US: The government careens from one crisis to another papering over cracks and placing Band-Aids on bullet wounds.
So, it’s left to the Fed to bludgeon inflation lower, even as fiscal policy designed to placate voters ahead of November works at cross purposes with monetary policy’s efforts to cool demand.
“Political necessity means central banks must counter political unpopularity with aggressive hikes,” Hartnett went on to write, noting that “the combination of Quantitative Tightening and fiscal policy desperation to counter inflation via impotent price controls, rebates, subsidies, gas tax holidays and nationalizations means more government spending and bigger deficits.”
The article from Hartnett is based on sound observations. However, we have reached an inflection point and when the worm turns it turns quickly. So, inflation will look bad until the trend changes- and likely it will change so fast the Fed will have to pivot quickly to avoid a severe downturn. Given the 2 year is now at roughly 3.20% the bond market is telling you they are guessing the terminal rate will be around 3ish percent. If they go 75 this time, they basically have another 75 left. Also, the inflation numbers are now more important than the employment numbers because this is now the FOMC focus. So, if prices adjust quickly you can bet Fed targets will change as well.
I’m wondering if anyone else views the Fed’s inflation mandate (at 2%) with suspicion in the current context. Seems to me the Fed has served many mandates beyond their oft-cited charter. Wouldn’t a relatively speedy reversion back to, say, 4.5% inflation suffice under the circumstances and leave the rest for the longer term? I mean they “tolerated” (lucked into?) sub-2% inflation for years and years as they worked towards realtizing that goal. Woudn’t it be sufficient to cap the froth in inflation to more tolerable levels and then paitently continue to work toward that goal over a period of years? Why does all of the overshoot need to be corrected in a single tightening cycle? This is not the Volcker-era in which inflation had not only gotten very high, but entrenched. I understand the need to keep expectations anchored, but won’t a relatively significant turn in the trend do much of that lifting? We’ve barely had a year of inflation > their 2% target, notwithstanding its breathtaking trajectory.
that’s pretty akin to my amateur thinking…publicly stating a completely unrealistic (short and likely medium term) goal of 2% further reflects this current Fed’s incompetence and credibility / public confidence issues…incremental goals and steps seem much more attainable which is why before we see a pivot I expect we’ll see a “pause,” then a subsequent reevaluation of whether pivot or resumption of hikes is indicated in our inflation dominated world…just my two cents there…
That makes a lot of sense to me. Ideally, this is an uber-hawkish and noisy foot stomping by the Fed to achieve a real inflection point as soon as possible. I only have a rudimentary understanding of inflation expectations and how they help widen the channel for actual inflation, but couldn’t the same thing be said about recession expectations? Seems to me all the recession talk could certainly influence companies to slow hiring or start layoffs, stop raising or borrowing money, slow investments, liquidate inventory, etc, then voila, you have your recession that everybody talked themselves into.
The Fed is among the most-watched institutions in the world, every word and punctuation market scrutinized by hundreds of pundits and millions of investors, so be realistic – the Fed will not and can not “tell it like it is”. All of its statements are crafted more for their impact on markets than to communicate information.
Understanding that, it should be clear why the Fed doesn’t out and say “hey y’all, inflation gonna be 2X normal next year” or “soft landing? ROFL and LMHO”. That would be the same as saying “let your future inflation expectations rip” and “quick, lay everyone off now”, which would be counter productive.
The army of pundits who chase clicks by criticizing the FOMC for not plainly acknowledging future possibilities, and who trumpet that as proof the Fed doesn’t know what is going on, are playing a cheap game. Or don’t understand the Fed’s game.
We don’t expect mothers to tell kids “it is not going to be alright”, generals to tell troops “you’re going to die or be crippled”, doctors to tell patients “this is a bad disease, stop trying”, venue operators to tell the crowd “fire, stampede over each other to the exits”.
If you want inflation forecasts, consult economists, read market gauges, or make them yourself. Don’t look to the Fed – its forecasts are signals about its policy and thresholds.
The Fed’s 2% is from thin air just like we all believe in the Dollar (more tangible than Manifest Destiny) and didn’t blink when paper became digital (it’s almost enjoyable to imagine the actual size of the paper Trillions of Dollars, especially as $1 bills).
They’re not meeting in August so they’re probably happy to do 75 bps and say they’re “awaiting data” (hoping to not have an emergency meeting…)
This leaves an incredible trading window where, if the cards line up, people can basically pretend from right now until September that, with this last 75 bps, the Fed has beat inflation… and then someone else will hold the bag when either:
A. Inflation persisted (probably because Putin)
B. Recession willed itself into existence
In either case the Fed will be forced into doing something right before the mid-term elections (and ironically the markets may react but whatever they do won’t fix inflation nor Main Street).
Very well put, JYL. I mostly agree, but just want to point out that the Fed does tend to be a stubborn one trick pony when it embarks on a course correction. I remember thinking just before December, 2018, if only Powell would say, ‘Ok we did some hikes, the first ones in a long while, now we are going to just stop for a bit and see what the effects are and get everyone used to these higher rates, before we decide what is necessary next,’ Instead it was all macho posturing, with “We are far from neutral” and the market decided that it was dealing with an idealogue, with an idee fixe and pressed the sell button.
Well it turned out we were way past neutral and after the market melted down going into Christmas, a chastened Powell, taught the market a bad lesson: that if the market tanks, Powell will wilt. This is why all the tough talk now is seen as necessary. His cojones are perceived as being soap bubbles.