Meanwhile, Back At The Ranch…

Between the de facto institution of one-man rule in China, the ongoing destruction of civilian infrastructure in Ukraine, political drama in the UK and a bevy of central bank decisions, the macro-minded have plenty to ponder in the new week.

While it’ll be tempting to dwell on global developments, there’s plenty going on back at the ranch, too.

US markets are coming off a wild week capped by a dramatic intraday reversal on Friday, when Wall Street Journal “Fed whisperer” Nick Timiraos suggested officials will consider how best to communicate a prospective step down in the pace of rate hikes after an assumed fourth consecutive 75bps move at the November gathering. Just hours later, Mary Daly made remarks which seemed consistent with the Timiraos article.

“In the week ahead, financial markets will grapple with the fallout of 10-year yields reaching 4.34% only to rally back <4.20%, and market conditions that continue to deteriorate in response to the level of uncertainty and central banking hawkishness that are defining the macro backdrop — fraught, but functioning,” BMO’s Ian Lyngen and Ben Jeffery said. “Despite investors’ reaction to the latest opinion offered by Timiraos, and the reversal of what had been a consistent climb in terminal rate assumptions, it is still too soon to rule out either a 75bps December hike or a 5-handle finish line for the Fed funds target band this cycle.”

The allusion to market depth is a key consideration. The ongoing volatility in rates is depleting liquidity at a time when bond market functioning is impaired. Janet Yellen’s Treasury is purportedly mulling a buyback scheme, and one prominent rates strategist warned the market is “potentially one shock away from functioning challenges.”

This week brings a bevy of data, quite a bit of which is top-tier in nature. On Thursday, the first read on Q3 GDP is expected to show the world’s largest economy expanded 2.3% last quarter, rebounding from two straight quarters of contraction (figure below).

At the risk of coming across as unduly dismissive, this is a total farce by now. The US was in a recession in the first half of the year according to the most commonly cited definition, but that’s not the definition the arbiter of recessions uses. In fact, the arbiter doesn’t use any strict definition at all, relying instead on a collection of indicators to inform what, ultimately, is a judgment call. The economy like grew a very non-recessionary 2.3% in Q3, and yet the odds of a real recession are allegedly 100%, according to Bloomberg’s model, and have been 100% for months according the yield curve which, according to market participants, is infallible.

As ever, I’d remind readers that nobody involved (not economists, not billionaires, not the NBER, not traders, not Bloomberg Economics, not any curves and certainly not any politicians) has any real idea what’s going on. It’s always a guessing game, even more so in 2022. If you want to know whether the economy is struggling, you have to watch what consumers are doing.

With that in mind, the personal consumption component of GDP is expected to post its slowest pace of growth since the onset of the pandemic for Q3, and markets will get a more granular look when income and spending data for September are released on Friday. Those prints will be accompanied by updates on the Fed’s preferred inflation gauge. With another hot core CPI report in hand, the PCE price numbers won’t change any minds about the size of November’s rate hike, although I suppose they could help make the case either way for December’s move.

Arguably, the most important data release in the US this week is the Q3 vintage of the Employment Cost Index, due Friday alongside the personal income and spending release. Some readers may recall that it was the Q3 2021 ECI report which, according to his own dramatized retelling, changed Jerome Powell’s mind about the viability of the Fed’s still dovish policy bent this time last year.

Q2 2022’s print was another scorcher, and Q3’s reading is expected to be similarly hot. Consensus sees 1.2% (figure above). Outside of the pandemic context, there’s but a single comparable reading going back more than 20 years (in 2003).

It’s not an exaggeration to say a hotter-than-expected headline ECI print or, alternatively, very elevated readings on key underlying aggregates, could rekindle any ultra-hawkish Fed bets that fell victim to Timiraos. Market pricing for the December meeting was as “low” as 58bps Friday, down 9bps from Thursday thanks to his Journal piece, and the subsequent assist from Daly (if that’s what it was).

Adding to the potential for drama is the final read on University of Michigan sentiment due an hour and a half after the PCE and ECI figures. Recall that the preliminary vintage of the October survey came packaged with unwelcome upticks on both the one-year and five-year inflation expectation gauges. The worst-case scenario for markets (and probably Fed officials too) would be hot ECI data, hot PCE data and upward revisions to the Michigan inflation prints.

Fed officials are in their pre-meeting quiet period this week, which means that in the event the balance of the data has the potential to shift the Committee’s thinking around the likelihood of another 75bps in December following November’s hike, it’d be left to Timiraos to communicate as much, assuming Powell wanted to send up any smoke signals.

To be clear, there’s no chance that the data could compel the Fed to opt for 100bps at the November gathering. And there’s probably no utility in front-running whatever Powell plans to signal about December early next month any more than Timiraos already has. But I wanted to emphasize why this sort of constant message refinement is perilous, not to mention incongruous with Powell’s purported abandonment of forward guidance in July. Thanks to Timiraos and Daly, markets will come into a data-heavy week with a mind to pricing in a step down to 50bps increments in December. If the data doesn’t cooperate, but the Fed nevertheless intends to dial down the pace starting at the December gathering, the Timiraos-Daly pivot trade risks getting hawkishly unwound into the November meeting. Any subsequent indication from Powell that 50bps is more likely in December than 75 would then be treated a dovish surprise, potentially triggering more volatility in rates and, quite possibly, in equities too. All as investors are forced to grapple with October payrolls and the results of the US midterms.

Also on deck this week in the US: Conference Board consumer confidence and critical housing data, including Case-Shiller and FHFA prices (Tuesday), new home sales (Wednesday) and pending home sales (Friday).