Terminal Patient

This’ll be stale as soon as Jerome Powell speaks on Wednesday afternoon, but only in the sense that market pricing will probably move. The rest will be relevant regardless.

Headed into the November Fed decision, terminal rate pricing had drifted back near the pre-Nick Timiraos peak around 5% (figure below).

The move to cycle highs was notable. It came on the heels of Tuesday’s JOLTS data, which I described as very bad for the soft landing narrative.

On Wednesday, ADP suggested job gains weren’t broad-based last month, but the “mixed” character of the report was belied by a very robust headline print, which beat the highest estimate.

As Joe Weisenthal (who probably doesn’t care much for me, but who may nevertheless be an infrequent reader after someone generously gifted him a subscription last Christmas) pointed out Wednesday, Bloomberg’s US Labor Market Surprise Index rose to the highest in seven months following ADP.

In short: There’s no cooperation from the data outside of the housing market, which pretty much has to cooperate with Fed hikes.


As Joe wrote, referencing the screenshot (above), “in the one area where the Fed clearly exerts significant control, the hikes are working [but that’s] a bank shot to start slowing other parts of the economy and so far, there hasn’t been much evidence that [the] ricochet is accomplishing much.”

There’s been no change in policymaker rhetoric. If anything, the “step-down” narrative was confirmed this week by the RBA’s second consecutive 25bps increment and accompanying allusions to “long and variable lags.”

Note that by “confirmed” I’m not suggesting the Fed is prepared to say, definitively, whether December’s hike will be 50bps or another 75bps. All I’m saying is that globally, central banks have decided that the front-loading phase is mostly over and that, from here, policy will need to be cognizant of the lagged impact from the tightening already delivered.

In the US context, that impact is mostly confined to housing thus far. Until that changes, any inclination on the Fed’s part to telegraph a step-down isn’t likely to trigger an outsized or sustainable repricing of terminal rate expectations. In fact, dialing down the pace opens the door to a longer hiking runway, or at least to the extent less aggressive increases now reduce the risk of a severe contraction later.

All of that said, you have to mind the ebb and flow. There’s a trade off. It’s possible that the step-down is too late — that a deep recession is already embedded and that we just can’t see it yet. If that’s the case, then higher terminal rate expectations from here just increase the odds of a hard landing, regardless of what the meeting-to-meeting cadence is.

The second pale blue arrow in figure (above) shows an increase in the implied amount of easing for the back half of 2023.

That’s one way of visualizing (or quantifying) hard landing risk.

Of course, you could also consult various cash curves, most of which began shouting something about recession months ago.


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5 thoughts on “Terminal Patient

  1. The chart directly above suggests that, today and for the foreseeable future, the U.S. economy cannot function without ZIRP (or pretty close to it). I refuse to accept that. (As if that matters.)

  2. If interest rate hikes aren’t getting the job done, more emphasis should be placed on faster balance sheet reduction.

    Interest rates are just a drag on credit-based growth and investment, but asset sales is raw liquidity absorption.

    To target strength in employment, I wonder why we aren’t talking more about increasing social security taxes. It will help dissuade employment (as the employer has to pay them too) and save for the future.

    1. I agree about asset sales, although many pundits have been dissing this approach lately. I also agree about the SS cap. Get rid of it entirely. That would help with SS now and the side benefit you mention is one I hadn’t thought of.

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