The Rug Pull

The Fed “executed the rare ‘dovish statement, but 10/10 hawkish presser’ surprise,” Nomura’s Charlie McElligott said early Thursday.

He referenced Jerome Powell’s “premature to pause” remark, delivered during Wednesday’s post-FOMC press conference in response to a question from the Washington Post‘s Fed reporter, Rachel Siegel.

While the most important bit from Powell was his emphasis on a higher terminal rate, if you pull up a simple chart of the S&P, it’s not difficult to spot that moment. The “premature to pause” exchange (it was actually more of an ad hoc monologue) stands out. That was the “rug pull” for equities (figure below).

Prior to that, Powell struggled to convince markets that the “higher for longer” message should outweigh the likely December “step-down.” Indeed, when he initially set out his “three questions” for policy in response to a question from Reuters, you could’ve mistaken the emphasis on the destination for rates as dovish, to the extent it suggested Powell was hammering home the smaller hikes point. That would’ve been the wrong interpretation.

Eventually, Powell succeeded in compelling markets to internalize the real message: When paired with the admission that rates likely need to go higher than the September projections tipped, the emphasis on “how high” and, eventually, “how long,” was overtly hawkish.

Powell’s differentiation between the “‘red herring’ focus surrounding the pace of tightening from what actually matters most — the absolute level where the terminal rate ultimately goes — was the ‘right’ hawkish outcome,” McElligott went on to write Thursday, noting that by the end of Wednesday’s session, the dollar and real rates were both higher.

Also higher: Terminal rate pricing. Markets are now pushing the envelope, so I hope that’s what the Fed was after. We’re now at 5% plus, and closing in on adding a hike (figure below).

There will be all manner of tweaks and adjustments to house calls for the terminal rate, and also plenty of mark-to-statement (so to speak) downward revisions to expectations for the size of December’s hike.

Nomura, which was a trailblazer this year with above-consensus Fed calls, now sees 50bps hikes in both February and March, and a 25bps move in May, all following a half-point move next month. Their terminal rate forecast is now 5.50-5.75%.

“While the likely lack of an additional 75bps rate hike in December is disappointing relative to our previous forecast, the broad arc of our Fed call remains unchanged,” the bank’s econ team said. “We believe markets continue to underestimate both how entrenched inflation is, and the Fed’s resolute intention to bring it lower, even at the expense of a recession.”

The US economy is resilient. The housing market not so much. Although continuous hikes don’t necessarily have to lead to ever worse outcomes for housing and equities, it’s certainly fair to suggest that a Fed which hikes near 6% from the lower-bound in just 14 months, is a Fed that “achieves” a material correction in home prices and also stocks.

The vaunted “wealth effect” remains in extreme peril, notwithstanding the customary day-to-day fireworks which are, at times, conducive to ostensibly inexplicable rallies. Eventually, hard landing risk will manifest in a bid for duration absent a nightmare scenario in which longer run inflation expectations become unanchored. That could provide relief for housing at some point. Later, once a recession is everyone’s base case, short-end rates will fall to reflect imminent Fed easing (i.e., the real pivot), clearing the way for stocks to recover in earnest.

Until then, it could be a turbulent ride on the Powell bus, which is apparently on “autopilot” to 5% and quite possibly beyond.