Thursday’s key macro story — or one of them, anyway — was the stark juxtaposition between the Fed’s message vis-à-vis market pricing for the terminal rate and the Bank of England’s.
Jerome Powell’s press conference the day before was a clear green light for markets to push the issue. Rates will likely need to go higher than the September projections suggested, he said, and markets should focus on that instead of the pace at which the Fed hikes going forward. Analysts upped their projections and market pricing pressed higher.
The BoE, by contrast, pushed back explicitly on market pricing. The bank’s new forecasts, delivered alongside Thursday’s rate hike, the largest in 33 years, suggested that if the market is right on the destination for Bank Rate, the UK economy may be headed for an eight-quarter recession and outright deflation by 2026. “We think Bank Rate will have to go up less than what’s currently priced into financial markets,” Andrew Bailey said. “That’s important because, for instance, it means that the rates of new fixed-term mortgages should not need to rise as they have done.”
This is crucial. It shows that there are binding constraints on rate hikes. There’s only so far central banks are willing to push the envelope, irrespective of inflation outcomes. Of course, they’ll excuse their reluctance to countenance overly aggressive market pricing by insisting that the tightening already delivered is sufficient to bring down inflation, but the implication from the BoE on Thursday was that if rates rose in line with market pricing, the economy might collapse and unemployment would nearly double. Jeremy Hunt channeled Obama this week while lamenting the scope of the UK’s economic tragicomedy. “This would be really interesting sh–t if I wasn’t in the middle of it,” he reportedly told business leaders.
The US 2s10s inversion reached new extremes Thursday (figure below) as the front-end sold off hard, while long-end yields ended near session lows, cheaper by just a basis point or two.
“While 2s10s has been as inverted as -241bps in March 1980, the outright yield levels during the 70s/80s offset the sticker shock of those depths,” BMO’s Ian Lyngen and Ben Jeffery wrote. “Said differently, a >200bps inversion is an entirely different animal when 2s are at 14% and 10s at 12% versus the current levels,” they added. “Nonetheless, the path to 2s10s at -100bps was further cleared by Powell’s reluctance to pivot even as other major central banks have grown increasingly cautious.”
Ahead of Friday’s jobs report (which, by the way, better not come in too hot, and definitely better not show another downtick in the unemployment rate and participation), news of tech hiring freezes and layoffs was rampant. Lyft is cutting 13% of its workforce, for example, and Amazon is “pausing” incremental hires in corporate for “the next few months.”
“With the economy in an uncertain place and in light of how many people we have hired in the last few years, Andy and S-team decided this week to pause on new incremental hires in our corporate workforce,” Beth Galetti, the company’s senior VP of “people experience” said, in a letter to Amazon employees shared publicly on Thursday. “We’re facing an unusual macroeconomic environment, and want to balance our hiring and investments with being thoughtful about this economy,” she added.
I’d reiterate that this continues to make for an interesting contrast with ongoing strength in the headline JOLTS numbers. Of course, they’re released on a lag, but so far anyway, tech’s “lean times” aren’t enough to reduce overall demand for workers in the US. I suppose it takes a lot of hiring freezes to make a dent in 10.7 million openings. And therein lies the problem for a Fed that needs a more balanced labor market.
US equities closed 1% lower, adding to Wednesday’s post-Powell rout. The two-session FOMC loss was the largest since 2020 (figure below).
The dollar was sharply higher. Sterling was crushed on forward policy and economic divergence worries.
“The onus for any market rebound [is] squarely on the next US CPI print. Until inflation improves substantially, the US interest rate glide path is higher for longer,” SPI Asset Management’s Stephen Innes said. “It shouldn’t come as a surprise to anyone that the Fed is having discussions about slowing the hiking pace,” he added. “It’s all about digesting Powell’s concept that the pace of hikes is not the focal point anymore.”
Rabobank’s Michael Every captured it well. In his Thursday missive, Every wrote that, “Powell doesn’t want to see financial conditions ease. He doesn’t want to see higher equities. He doesn’t want to see lower bond yields. He doesn’t want to see a weaker dollar. The old party paradigm is over, much as markets refuse to accept it.”
Every’s comment seems particularly relevant in that Powell seems to attribute a significant proportion of the current inflation to the “wealth effect” which, in turn, he sees as an outgrowth of the rise in the financial markets. Powell has made it clear he wants to reduce the wealth effect until it no longer drives inflation.