2023 Rate Cut Standoff Puts Fed, Markets On Collision Course

If you ask Mary Daly, a slowdown in the US labor market is “completely worth it” if it means taming prices.

She spoke Wednesday during a Twitter event hosted by Reuters. It was the second time this week that Daly weighed in.

Although she was careful to suggest policymakers not “get ahead of themselves,” she nevertheless pushed back on hopes for a dovish pivot. In fact, she delivered some of the most explicit rhetoric yet vis-à-vis market pricing for the policy path and, by extension, the summer stock rebound.

Markets, Daly said, are ahead of themselves when it comes to pricing Fed cuts for next year. Policy isn’t even at neutral yet, in her estimation, and the Fed won’t cut rates in “a few months.” Instead, rates will remain elevated for up to a year. So much for being done with forward guidance, although that’s not the kind of forward guidance markets want to hear.

She went on to say that she doesn’t see anyone experiencing a recession, claimed there’s not a tradeoff between jobs and inflation, and conceded unemployment will probably rise “a little.”

Data out Thursday showed jobless claims rose “a little” in the week to July 30. At 260,000, initial filers were up 6,000 from the prior week’s downwardly revised headline. At 254,750, the four-week moving average was the highest since November (figure below).

Continuing claims for the week ended July 23 were 1.42 million, higher than expected and the most since April. The prior week’s figures were revised higher. It’s “not an encouraging read on hiring as those who are being laid off are increasingly staying laid off,” BMO’s Ian Lyngen remarked.

Separately on Wednesday, Neel Kashkari sought to reinforce a message delivered during Sunday’s CBS cameo. The Fed, he said, during a virtual event for the Journal of Financial Regulation Conference in New York, is “laser-focused” on controlling inflation. He called the rate cuts markets see in 2023 “very unlikely.”

I’ll say it again: So much for being done with forward guidance. I’m not the only one who gets that joke by the way. “For a group supposedly keen on dialing back forward guidance, Fed officials sure have been doing plenty of guiding this week,” Bloomberg’s Cormac Mullen wrote Thursday, noting that although pricing for this year’s meetings has firmed amid the cacophony, markets still expect at least two rate cuts next year.

Given the still tenuous outlook for a US consumer experiencing the largest inflation-adjusted wage cuts in modern history and the distinct possibility that the labor market will look quite a bit different in January than it does now, it’s very unlikely the Fed will succeed in convincing markets that rate cuts are out of the question next year.

That’s not (at all) to suggest they can’t browbeat STIRs into paring bets on a panic pivot — they do set policy, after all. So, if they continue to pound the table and insist that barring a depression (and maybe not even then) rates will make it into mildly restrictive territory and stay there for as long as it takes, markets will be discouraged, but not totally deterred. It’s not realistic to expect traders to unlearn 12 years of classical conditioning (which dictates a dovish pivot at the first sign of trouble) in just seven months.

So, they’ll keep pounding the table. “If nothing else, the Fed is upping the ante in its bid to counteract any hit to credibility that might have occurred as a result of the delayed response to the initial spike of inflation [and] for the sake of medium-term credibility, the Fed will need to follow-through on the pledge to bring inflation back into the prior range  — regardless of how long the endeavor takes and the ultimate cost in terms of higher unemployment and demand destruction,” BMO’s Lyngen said, in a separate note.

“The Fed got the memo in a big way it seems, as Committee speakers grabbed the rates market by the scruff and slapped some ‘inflation hawk’ sense into it,” Nomura’s Charlie McElligott wrote. “The reality is that despite slowing activity data, the labor market’s continued strength, record-low U-rate, still [elevated] average hourly earnings and record high wage growth, all conspire against the Fed’s ‘inflation-killing’ goal — they need to create demand destruction.”