The word “shock” was bandied about on Thursday to describe the Fed’s new dot plot, and I have to say: I’m not sure it’s especially accurate.
Flagging a terminal rate of 5.1% after saying (as virtually every Fed official did last month) that the new median projection for peak rates would be higher than the 4.6% tipped by the September SEP didn’t strike me as particularly “shocking.” Markets were betting on a ~5% terminal rate prior to Tuesday’s dovish CPI report. Leaving the door open for 5.25% is really just preserving an option to squeeze in one additional “regular”-sized increment atop pre-November CPI pricing in the event it’s necessary. That’s not shocking.
To me, the disagreement between the Fed and markets isn’t really about terminal. Nobody is going to be particularly aggrieved if the Fed manages to cram in one additional hike to get squarely into the “fives” (as Jerome Powell put it) as long as the economy isn’t unravelling. The irritability will come if the Fed holds rates at or near terminal in the face of an obvious economic downturn.
Although Jerome Powell was pretty insistent on the “higher for longer” narrative during Wednesday’s press conference, he might just be buying time. It’s possible Powell thinks that with two consecutive “right direction” CPI reports in hand, he feels like he just needs to hold the line for a few more months (e.g., to give the appearance of hyper vigilance, and thereby keep the animal spirits at bay) while allowing a disinflationary process that’s already in motion to play out.
In a Thursday note, Nomura’s Charlie McElligott delivered a conceptually similar take. “To be honest, yesterday’s Fed was nothing earth-shattering to me,” Charlie wrote. Below, find McElligott’s brief assessment which, I think, is generally accurate.
Powell had to keep saying what he believes markets need to hear (hawkish-y rhetoric to control FCI to keep buying time for inflation to soften, which is clearly trending in the ‘right’ direction from the US perspective), but still very much on board with that constructive Fed policy tightening cycle ‘phase shift’ I noted a few weeks back after the Brookings speech, where the focus is no longer about the ‘absolute level of terminal,’ but instead, the final stage [and] the amount of time we hold restrictive at terminal before ultimately pivoting easier.
“Hawkish dots due to ongoing labor and wages strength, versus post-CPI expectations for lower dots” is the supposed story of the market reaction to the FOMC, but it seems the real trepidation from markets might actually be about the Fed’s continued persistence in ‘higher for longer’ messag[ing], particularly as it relates to the Committee projecting a pessimistic view that the recent deceleration in inflation will be sustained, and/or that inflation is ‘entrenched’ likely due to labor and wages, a big Fed ‘no no.’
[The] very surprising Fed projection on end ’23 core PCE inflation at 3.5% looks ‘aggressively stale’ in light of this week’s CPI data (i.e. way too high), which again opens the door [to a] marginally [higher] probability of an overtightening accident, so risk didn’t love it.
But the thing is, I feel pretty emphatic that both the Fed and ECB are using this approach — this ‘threat of entrenched inflation’ story — to allow for their hawkish ‘higher for longer’ message to keep buying them time while the inflation, labor and wage data is actually moving in the right direction in the background.
This has me thinking that next year, we just might get that ‘less-bad-than-anticipated’ outcome.
Good take
It is a good take. I agree. But the best laid plans often go awry.
The best news to me is that we have runway to manage this thing. If there are any impulses either way, the hope is to manage the economy over a period of months in preparation for coming year. We don’t want to wrangle this calf in just a few seconds.
It will be a slog next year. There are significant recession risks. The European economy is likely going to slow dramatically due to sanctions and the war. Additionally, the Chinese people and their economy are fumbling Covid and tripping over each other under the stewardship of Xi and the CCP. They’re not going to have a pleasant winter either. The US will not escape the drag that Europe’s troubles and China’s nearsighted economic management will impose on the world.
I agree, not likely they get this just right, but I think H/Chuck make a good point about the way the fed is behaving in relation to how they want to be perceived and their aspirational outcome. If only they can avoid a train wreck for three more months…
Our Dear Leader has made reference to the non-carbon based entities often dominating intra-day price action. Yesterday was a remarkable example of that. I was on a day off, chopping up vegetables in the kitchen during Powell’s press conference. The swings in the indices were remarkable, obviously triggered by algos reacting to certain key words.
Ah, remember when the capital markets were venues to allocate capital between savers and entrepreneurs and home buyers? Rather than casinos for speculators?
Yes, how true. But I also remember Merrill Lynch charging me ~$25 to trade 100 shares of stock.
Gamblers at the casino get “free” drinks. Enjoy your “free” trades. Neither the casino’s nor Merrill Lynch are losing money. https://www.investmentnews.com/raining-records-merrill-lynch-216011
Heaven forbid we ever get a Fed chair who stutters!
Maybe Powell should wear an earpiece and have a trader watching the tape and giving him instructions. “Say that word again. And again! Once more and she’ll be down for the count!”
“I’ve got a fever, and the only prescription is more cowbell!”
The Fed has delivered more cowbell, the only medicine they have for inflation. This prevents “irrational exuberance” into the year end.
Over the last several months, probably since June in fact, the narrative continually shifts to “the Fed doesn’t really mean it.”
Here McElligott does it again.
…this ‘threat of entrenched inflation’ story — to allow for their hawkish ‘higher for longer’ message to keep buying them time…
Words such as “threat” implies that it is not real. Words such as “buying time” implies that it is only a ruse.
It only takes a few days in this market for the narrative to shift right back to bullish.
The Fed was not communicating a bullish message. That did not happen.
But the market will find a way to re-frame it as bullish.
Wall Street wants to run it higher. I am not sure why. A good sell-off can be very profitable if played right. But somehow, they always revert back to the same thing.
We already know that Jerome can turn on a dime (December 2018)……and I am willing to place a bet on that happening again sometime in 2023.
Kind of like a dad who says he is going to ground their kid if they get home after 1am. Then, the kid gets home at 2am. The dad makes an exception but continues to repeat the rule- in a louder voice as if using a louder voice will offset the fact that he previously made an exception!! (I only did that a few times 🙂 )
Thank goodness I have pretty much done nothing with my investments this year- if I had tried to time/predict, my accounts could easily be suffering from massive and unrecoverable realized (as opposed to bad unrealized) losses because there is no way I could have traded the market in 2022. Full disclosure- I am a “dinosaur”- as I still long for the days to return when I can use fundamental analysis to identify an undervalued stock!
I have a theory, but I have no data to back it up.
The theory is, that as wealth becomes more and more concentrated in the hands of the few, this in itself will tend to suppress market volatility.
For the simple reason that the wealthy don’t need the money, and they don’t react to external events, the same way that less wealthy people would.
Right now, I think about 50% of all stocks are owned by about 1% of the people.
Now this 1%, they don’t care about a recession. They are quite happy to let the money sit there, perhaps for two or three years, until we get to the next easing cycle. They simply won’t sell, under any circumstances. Doesn’t matter if the stock market gets cut in half. They’re not selling. Only death itself, through inheritance, creates any need to sell.
No selling = reduced volatility.
We used to have the Bernanke put. Now we have the 1% put.
The next easing cycle is going to start a lot quicker than in 2-3 years
Completely with you on that one!