The Fed Versus Taylor Swift

What came first, inflation, market pricing, Wall Street Fed calls or Fedspeak?

It’s hard to say these days. We’re stuck on a kind of merry-go-round. Or in a hall of mirrors, if you like.

Goldman on Wednesday added a hike to their official Fed call. The bank now looks for 50bps in December, then three consecutive 25bps increments after that, for a peak of 5-5.25%. The figures (below) illustrate Goldman’s forecast versus market pricing.

“The median FOMC participant projected a peak funds rate of 4.5-4.75% in September, but Chair Powell said at the November meeting that this is likely to rise in December,” Goldman’s David Mericle said. “We expect the median to project a peak of either 4.75-5% or 5-5.25% and look to finalize our expectation in our December FOMC preview.”

Of course, Jerome Powell’s concession that rates likely need to go higher than indicated by the September SEP was based on realized inflation which, at the time (i.e., at the November press conference) was still moving in the wrong direction. But there was a sense in which he was also just taking what the market was giving him. In mid-October, market pricing for the terminal rate started to bump up against 5%, at which point Wall Street Journal “Fed whisperer” Nick Timiraos and Mary Daly tipped the Fed’s intention to convey an eventual step-down in the pace of hikes. That prompted markets to rethink whether 5% was achievable this cycle, but by the time Powell got around to confirming the step-down narrative, pricing was back near 5%.

Following the November Fed meeting (and Powell’s press conference) Wall Street adjusted their Fed calls. Those adjustments are ongoing, and while predicated in part on projections about the evolution of inflation, there’s certainly a “mark-to-Fedspeak” dynamic in play.

So, again, this is a hall of mirrors. It’s not clear who’s marking to what. Ostensibly, it all comes back to real-world inflation, but there’s absolutely a sense in which the dynamic becomes almost self-enclosed during some weeks — market pricing moves one way, Fed officials either confirm it or not, Wall Street adjusts its forecasts, Fed officials lean back in the other direction, market pricing shifts again, and so on. Admittedly, Street calls are slower moving, but remember: We only get two official inflation readings each month. And they’re backward looking.

Daly this week suggested rates likely need to rise another 100bps (she also said, “Pausing is off the table right now. It’s not even part of the discussion”), Christopher Waller was generally hawkish and on Thursday, Jim Bullard said that 5-5.25% was the “minimum” he’s aiming for.

During a presentation in Louisville, Bullard cited various Taylor Rule iterations to suggest that achieving the Fed’s “sufficiently restrictive” goal could mean raising rates as high as 7%. The figure (below) is from Bullard’s presentation, which carried the somewhat banal title, “Getting into the Zone.”

“My approach to this question is based on ‘generous’ assumptions — assumptions that tend to favor a more dovish policy over a more hawkish one,” he said, of the “sufficiently restrictive” question.

The “key point,” Bullard emphasized, is that “even under these generous assumptions, the policy rate is not yet in a zone that may be considered sufficiently restrictive.” Note that under a “less generous” regime, rates should’ve been near 8% earlier this year, when they were still parked at the lower-bound.

Bullard, who was reborn as an ardent hawk in 2022, took a grim view of the progress made so far by the Fed after 375bps of hikes. “Thus far, the change in the monetary policy stance appears to have had only limited effects on observed inflation,” he remarked.

As you can imagine, Bullard’s presentation triggered a knee-jerk reaction in rates. Terminal rate pricing jumped back to ~5%, up 10 or so basis points (figure below).

At this point, market pricing is back behind Wall Street forecasts and also behind the Fed’s outlook. In other words: We’re back in a situation where the market doubts the Fed’s capacity, willingness or both, to deliver.

That doubt could in part reflect the disparity between R* and R**. Those unfamiliar are encouraged to peruse the full backstory here, but suffice to say that after a dozen years of optimizing around NIRP, ZIRP and LSAP, markets may not be able to tolerate rates that are “sufficiently restrictive” to bring down inflation in the real economy.

That disparity, to the extent it exists, is a problem for the Fed, as it suggests getting inflation under control could entail crashing markets.

“It now seems abundantly clear that markets can’t handle much more rate hiking after a decade of duration- and leverage-binging, as evidenced by the list of breakage experienced over the past 12 months,” Nomura’s Charlie McElligott said Thursday. “In the meantime, the real US economy (admittedly outside of housing and the structurally-shrinking manufacturing sector) keeps banging along, where in peak (cringe) anecdotal fashion, restaurant reservations are ‘no offer,’ luxury malls are packed, airline tickets are running 2-3x ‘sanity’ levels, there’s a no-locate on new Range Rovers in New Jersey until 2024 and all while New Yorkers are apparently lifting $21,000 Taylor Swift tickets for next summer.”

I ummm… I don’t know what to say about any of that. I wear tracksuits, I don’t fly, I wouldn’t buy a Range Rover if my life depended on it (if that’s your price bracket, e-mail me and I’ll give you a dozen better suggestions) and I’ve never heard a Taylor Swift song. Or at least not intentionally.

In any event, Bullard’s “less generous” (John) Taylor rule calls for rates at 7%. I’ll leave it to readers to determine what a Taylor (Swift) rule based on $21,000 concert tickets implies for the terminal rate.


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9 thoughts on “The Fed Versus Taylor Swift

  1. “It now seems abundantly clear that markets can’t handle much more rate hiking after a decade of duration- and leverage-binging, as evidenced by the list of breakage experienced over the past 12 months…”

    I’d like to see McElligott’s evidence for this statement. From where I sit — which most definitely is not “in the room” — the past twelve months in financial markets looks like a pretty ordinary correction of a situation (free-money-fueled global bubble) that was unsustainable. Has the abrupt reversal of CB policy caused things to break? Sure. Are we on the precipice of a global financial crisis with the Feds fund rate and 10yr at ~375bps? I want to see concrete evidence.

    1. “… which most definitely is not ‘in the room'”

      You answered your own question.

      Also, the UK pension complex nearly imploded last month.

      And no, it’s not “a pretty ordinary correction.” This is the worst year for US bonds since George Washington was president, according to one index.

      Also, find me a year when IG corporate credit was down 20% (don’t waste your time — you won’t find one).

      The goal of monetary policy isn’t to push the world to the “precipice of a global financial crisis.” That’s not how this works.

      I realize you’re in that camp of people who likes to leave a passive aggressive comment on any article that even vaguely suggests the Fed might be on the brink of making a hawkish mistake, but if your threshold for dialing back rate hikes is “concrete evidence” of an imminent global financial calamity, then God help us all if you ever end up in any sort of role that allows you to make decisions about policy.

      1. I mean, I could try to rebut your points: yes, bonds had a terrible year — after a historic 40-year bull market; UK pension managers (and their advisors) have no more credibility as stewards of other people’s money than SBF; many of the people warning about a hawkish Fed policy mistake are anxious about their speculative, over-levered positions — but why bother. Not trying to be passing aggressive, just trying to call BS on the financialization of the U.S. and global economies. But, hey, if private-the-profits socialize-the-losses is the name of the game, I’ll try harder to get with the program.

        1. This is a much better comment than your original comment, which is what I was after.

          But, also, we have to deal with the system as it is. And, as you note, everything is thoroughly financialized. We can’t just pretend as though that isn’t the case. It’s obviously our fault that it became this way, but one can conjure myriad examples of scenarios in which we place ourselves in suboptimal positions, but have to be careful about how we go about extricating ourselves, lest we should inadvertently do more harm than good. The same principle applies here. There’s a way out of this. But it probably isn’t 8% Fed funds.

  2. Drawing on their extensive private sector experience, Bullard & Waller continue to try and “out-hawk” one another. What is the point of all of these Fed utterances? (Besides setting up to be Ronnie-D’s choice to be Fed chairman?)

  3. Raising interest rate to cool demand really only hurts the middle class that are drowning in debt, be it consumer or mortgage. (btw, many mortgages in Canada are variable rates tie to the BoC rate). Wealthy pay cash and don’t complain about $2000 shoes went up 10%.

    The middle class will mindlessly go about their life, while higher mortgage and debt payment sip away at their savings, and eventually be cash flow negative and increasing rely on debt to pay for the monthly negative cash flow. However, this will take time to build, and even more time for it to become a crisis. It takes a few months to go from paying credit card bill in full, to paying minimum, to skip payment, to become delinquent, and finally collection agency starts calling.

    Even under money stress, middle class will still travel after 3 years of Covid lock down, and figure out the payment later.

    Very few middle class actually do a budget, never mind budget with a stress test on possible inflations and higher mortgage rate. If they are doing this regularly, I don’t think they remain in the middle class for too long.

  4. Recent history (2018) suggests that eventually the Fed will blink first. Maybe this time is different. The Fed shot itself in the foot when it pivoted back then, now the markets have to price in an eventual pivot before the Fed reaches the rate levels that they keep saying is their target. I agree that the Fed should just keep their collective mouths shut and adjust rates as they deem necessary. Forward guidance is only good if the Fed does what they say they will do. Maybe if they kept their guidance down to a shorter time window such as “over the next three months we anticipate…”?

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