“It’s certainly bold from a timing perspective,” Nomura’s Charlie McElligott said.
He was referring to the burgeoning step-down from developed market central banks. On Saturday morning, I spent some time editorializing around the rather unfortunate optics of a “blink” from policymakers.
Australia, Canada and Europe, are apparently deescalating their assault on inflation, and the Fed is rumored to be considering a subtle shift in its own tactics, even as price growth outcomes take another turn for the worse.
Read more: Bad Pivot Optics
Markets have predictably embraced the perceived mini-pivot, but if the familiar paradox wherein risk asset rallies themselves force policymakers to disavow any dovish inclinations they might harbor (for fear of encouraging outcomes conducive to easier financial conditions) reasserts itself, this could be yet another self-defeating false dawn.
Of course, it could also just be plain old premature. If inflation outcomes continue to worsen as they did this month (both in terms of backward-looking, September and Q3 prints, and “real-time,” preliminary, “flash” reads on October price growth), then the step-down could be over before it starts.
The figure (above) just shows market pricing for the Fed. November’s 75bps move is fully priced (obviously). The December meeting is priced at 59bps. Terminal rate pricing is around 4.85%. It exceeded 5% this month at the highs, before Nick Timiraos’s Journal piece and same-day remarks from Mary Daly compelled a rethink.
McElligott called the appearance of a coordinated deescalation “stunning” for two reasons. First, most of the relevant locales “are still seeing hot MoM inflation prints, and still ‘too-strong’ labor markets versus [the] need to cool demand-side inflation,” he said. Second, rates aren’t meaningfully restrictive anywhere other than perhaps New Zealand. Fed funds is barely neutral. The ECB’s depo rate is below neutral (probably). And so on.
“I liken it to the [football] phenomenon where guys are running free into the end zone, looking into the crowd already sensing their glory, and in their celebratory enthusiasm, spike the ball before crossing the goal line,” Charlie went on to write, noting that “these central banks are making a big bet that inflation is being solved-for in ‘lagged and variable’ fashion through the past year’s tightening efforts, roll-over port backlogs, [falling] freight and shipping [costs] and inventory ‘bullwhip’ disinflation, [along with] simple base effects.” They also appear to be putting a lot of faith in market-based forward inflation measures.
All of that despite little in the way of concrete evidence to support the notion that inflation is on the back foot. Indeed, the Cleveland Fed’s inflation nowcast is at YTD highs (figure below). And energy prices are firming.
Even as they downshift and fret over rising recession risk, most policymakers readily concede that there are no obvious signs of inflation abating.
So, as noted above, the market risks undermining its own cause. Overzealous attempts to front-run a policy shift could be self-defeating. “The issue is that the reflexive nature of markets, where we ‘anticipate the anticipators,'” means trading the “‘pause’ / ‘mini-pivot’ / ‘step-down’ information” in a way that “then eases financial conditions,” McElligott said.
But the Fed needs restrictive conditions, and although they generally avoid saying this in explicit terms, key mechanisms for achieving that include raising the cost of capital and engineering a reverse wealth effect. Falling real rates, a softer dollar, lower terminal rate expectations and rollicking stock rallies are counterproductive.
“So, perversely, and yet again, the anticipation of what we all logically know has to eventually happen with the Fed’s hiking cycle — you can’t hike rates at increasing magnitude forever — becomes yet another headwind for the Fed and other central banks, as ‘premature anticipation’ of a tilt back towards easing acts to stimulate the wealth effect and animal spirits,” Charlie said.
I think many of these analysts are navel gazing. The central banks are still hiking rates and engaging in qt. Only on wall street would this be considered a pivot. Instead of hiking at a break neck speed they are shifting to hiking at a fast pace.
Sorry, but no. It’s not a coincidence that the RBA downshifted (below consensus), then the BoC totally surprised on the dovish side (below consensus), then the ECB dropped key language from the statement (knowing full well that’d be picked up by algos and markets immediately, which it was), all while Timiraos and Daly (after Brainard set the stage) telegraphed a potential messaging shift from the Fed. The idea that that’s “nothin’,” or just the normal course of business with no communication between the banks, beggars belief.
Sorry tightening by 50 instead of 75 ain’t a pivot. The stock market may like it, but that does not make it a pivot. Now, you may think the market thinks that will lead to a pause and that then after that a rate cut dow the road. That’s fair. But raising rates is not a pivot. It is still tightening financial conditions.
Incorrect. Objectively incorrect. A Fed that delivers a dovish hike and accidentally sparks a decline in real yields, a weaker dollar, tighter CDX and an equity rally is a Fed that eases financial conditions. Literally. Pull up GS Fin Con index, dissect it by component and you can see this as it happens by meeting.
As usual, you’re speaking in broad, generalized terms, and I’m telling you what actually happens on the ground and how that impacts markets. There’s no debating me about things of that nature. I’ve been doing it too long.
Obviously, that doesn’t rule out a hawkish hike next week, but what I’m telling you is that when you say that a rate hike always tightens financial conditions, that simply isn’t true. It’s factually inaccurate. It depends on the market reaction. Fed funds is only one component of Fin Con indexes. The others are 10-year yields, credit spreads, stocks, the dollar, and so on.
For those interested, the link (below) will pull up a chart showing the breakdown mentioned above for the weeks following the July FOMC meeting. It illustrates what happened after that month’s 75bps hike, which went over dovish with markets because Powell wasn’t emphatic enough during the press conference (a mistake he atoned for in Jackson Hole):
https://heisenbergreport.com/wp-content/uploads/2022/10/JulyFOMCGSFCIReaction.png
Thanks, Ria. I really enjoy your challenges to Heisenberg’s reasoning because his replies yield more perspective and further benefit my own.
What I appreciate from him in this case is his caution that calling any step down may be premature. The inflation may not step down. Q3 prints and October price growth may throw a wet blanket on any idea of a step-down.
Midpoint between the January highs and the recent lows is around SPX 4200.
Just the hint of a pivot (50 basis points versus 75 basis points in December) moved us from those lows all the way to 3900 (a 400 point move) in record time.
Imagine what would happen if we had a real pivot. We would probably be back to all-time highs in about a week.
Yes, this market is reactive.
Is the Fed “happier” with the market at 4,000 or at 3,600?
3,600 got us some walk back on the tough talk.
Will 4,000 get us a walk back of the walk back?
I don’t invest based guessing the relative dovishness of the next Fed statement, but if I had to, I think we’ll see firm hawkish language again. It’s clear the market will take the smallest of small reasons to get massively long both stocks and bonds and unwind the Fed’s efforts to date. I can’t see the Fed wanting to encourage that response in any way.
Inflation is financial cancer to the whole economy. The last time US inflation took hold from rock bottom levels is the 20+ year period starting in the early 1960’s. Over this period, there are four clear cycles of rising inflation. In 1961, the average fed funds rate was about 2% and the average CPI was just over 1%; thereafter, the trend for both was up.
Peaks for each form in ~1966, ~1969/70, ~1974 and ~1980/81, and with each peak (and the in-between floors) occurring at higher % rates than the prior cycle. For the first three cycles, data series seems to suggest the “fed pivot” to lower rates happened relatively quickly and the decline in fed rates may have been equal to or faster than the decline in CPI. It’s not until the fourth cycle where the full “fed pivot” is delayed (while there was some variability, rates were held higher than inflation for an extended period of 18 to 24 months) and the subsequent rate of fed rate declines appears to happen slower than the coincident decline in inflation.
Now, as with that 1961 to 1982 period, we don’t like the taste of the chemotherapy. The social and political pressure to bring interest rates down is strong. But if we don’t take the medicine now, the risk of this cancer not going away for long is real.
I think you are correct that the social and political pressure to bring rates down is strong and will likely continue in a crescendo as evidence of an actual recession emerges. If we get a downturn next year accompanied by real job loses and higher unemployment it will be very hard for Dems to retain the presidency in 2024, whomever the next GOP president is, but specially if we get Trump back, will effectively dismantle the Fed by a combo of real public pressure while installing loyal cronies. That future Fed will not fight inflation, it will only pursue policies that favor the administration. Our current Fed has to make a Sophie’s choice, there are no good outcomes, actually fighting inflation might pose an existential risk to the Fed and our democracy, failing to curtail inflation might lead to the same result but perhaps our democracy survives, hard to tell, hard choice to make.
Inflation… at a certain level… is a feature not a bug given the huge amount of government (and other) debt globally.
At current rates, the Fed becomes “insolvent”.
Besides, rate hikes are a crude way to address inflation. And as OPEC recently pointed out…Powell is not the only one with levers to pull.