Price Discovery. Via Tasseography

Real-time Fed tasseography is a very difficult undertaking. Almost as a rule, asset prices aren’t very good at it.

Market participants tend to hear what they want to hear, and algos trade headlines not nuance. Price action observed in the immediate aftermath of FOMC decisions, and particularly gyrations engendered by press conference soundbites, isn’t necessarily to be trusted.

That price action is a manifestation of two things. In part, it’s algorithms trading on key words, and chasing each other around. But it also reflects a community of people (traders) interpreting scripted and unscripted remarks from one person (the Fed Chair) whose job it is to convey the disposition of several other people (the FOMC). That process is influenced by still another group of people (reporters from mainstream media outlets), all with different agendas and some possessed of very little in the way of subject matter-specific competence.

Hopefully, you can see where (and why) things might go wrong in that price “discovery” process. After the fact, journalists are tasked with penning recaps which read like precisely what they are: Belabored attempts to reconcile asset prices with the Fed Chair’s words, even when no such reconciliation is possible, let alone plausible.

Wednesday’s Powell-inspired price action wasn’t the most farcical example of this objectively frivolous endeavor, but it landed on the wrong side of center on the continuum where one end is labeled “ridiculous” and the other “pretty rational as tasseography goes.”

A couple of things stood out. Most obviously, there was no overt dovish pivot. Strict data dependence is only as dovish (or hawkish) as the data allows. Relatedly, the withdrawal of forward guidance is conducive to more volatility, not less. The whole point of forward guidance is to foster predictability and transparency, which effectively underwrites the short vol trade in all its various manifestations. The removal of forward guidance should have the opposite effect, all else equal.

It’s with all of that in mind that I present a brief selection of abridged excerpts from analyst commentary, all of which underscore the notion that whatever you want to say about Jerome Powell’s July press conference, “unequivocally dovish” (as some assets appeared to trade it) probably isn’t the right interpretation.

Wednesday’s FOMC went off seemingly as expected. Even though the outcome was well-anticipated, the market reaction was, to us, surprisingly dovish. The dollar slumped and risk assets rallied. The only dovish comment we heard at the press conference was “as the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases…” Does the market interpret this remark to mean that a pivot is coming? We think that is a far too generous reading, and instead prefer to focus on his multiple admonishments that inflation needs to come down, and that policy needs to tighten further from here. The market clearly didn’t get that message — at least on Wednesday afternoon. The move away from forward guidance can lead to higher volatility in rates — and by extension, currencies. Every datapoint becomes a referendum on the next central bank meeting and can impart wild swings into the pricing of future interest-rate moves. — John Velis, BNY Mellon

A rally in duration-sensitive assets, with tech equities outperforming, implies a dovish pivot from the FOMC in its decision to hike the Fed funds by 75bps. With an increasingly data-dependent Fed, the volatility of central bank decisions increases, requiring a higher risk premium. Hence CPI releases have become even more critical. Slow-to-decline CPI inflation would suggest market pricing is not aggressive enough. — Stephen Innes, SPI Asset Management

Fed focus remains on inflation despite recession concerns. The pace of hikes should slow, but monetary policy should be increasingly tighter through year-end. Increasingly investors are concerned about the US economy and fear recession. The Fed is showing sensitivity to these concerns, but this has yet to deter it from the inflation fight. — Stephen Gallagher, SocGen

Interestingly, the market judged Chair Powell’s comments and the absence of policy guidance as mostly dovish. It was always going to be a tough job for the chairman to signal that 75bps increases, while still possible, were not likely to continue going forward without the market reading it as a possible policy pivot. We expect Fed officials to double down on more hawkish policy guidance in the coming days if financial conditions overreact to the Fed Chair’s comments. In our view, the FOMC will continue to put a larger weight on inflation concerns than on rising recession risks (for now). In effect, in his post-meeting presser, Powell repeatedly downplayed any insinuations that the economy is imminently heading into a recession, and also acknowledged that the Committee thinks that “it’s necessary to have growth slow down” accompanied by a “softening in labor market conditions.” All told, we are of the view that persistent strength in core CPI data, led by stickier shelter price inflation, means that “compelling evidence that inflation is moving down” is likely still months away. — Oscar Munoz, Priya Misra, Gennadiy Goldberg, TD

The FOMC is now fully data dependent and doesn’t want to pre-commit, opening the door wide for further volatility in the front-end of the curve. There are eight weeks until the meeting in September, with lots of economic data releases (e.g., two jobs reports, two CPI reports, lots of other activity data) and potentially numerous geopolitical updates in between. — Stefan Koopman, Rabobank

Our take is that the next meeting remains a question of 50bps versus 75bps, not 25bps versus 50bps even as the Fed contemplates beginning to move more slowly to assess the economic impact of this year’s cumulative tightening endeavors. Shifting to a meeting-by-meeting bias in terms of future moves was interpreted dovishly by both bonds and stocks, although in practical terms we expect additional rate hikes into a dimming outlook will continue to push the curve flatter. The takeaway from the press conference was that policy rates are going to continue to rise, although now that some version of neutral has been achieved, the debate will shift to just how restrictive is appropriate and more germanely for timing the resteepening of the curve, how long the Committee will able to keep rates at terminal. We are not yet at the juncture when the Fed needs to actively push back against the market pricing in cuts in early 2023, but suspect the shift to an on-hold bias will eventually run counter to investors’ expectations with tightening fallout for financial conditions and flattening implications for the shape of the curve. Whether that is a late 2022 or early 2023 reality will be a function of the degree to which consumer prices moderate, and central bankers’ success in keeping inflation expectations anchored. — Ben Jeffery and Ian Lyngen, BMO

Markets seemed to cling to the notion that the Fed will slow down tightening from now, which resulted in an equities rally as well as some re-pricing lower in rate expectations for the remainder of the year. The OIS curve currently embeds 100bps of extra tightening at the September, November and December meetings combined. We do expect the Fed to switch to 50bps in September, but vague forward guidance and the migration to a fully data-dependent approach mean that a lot can change from now until the next meeting. — Francesco Pesole, ING