The first question Jerome Powell took during this week’s post-FOMC press conference related to the recent easing in financial conditions, and the potential for higher stocks and lower bond yields to undercut the Fed’s inflation-fighting efforts.
Rather than seize the opportunity to scold markets for impeding policy, Powell offered a boilerplate response and suggested that irrespective of short-term oscillations, financial conditions are markedly tighter than they were prior to the onset of the most aggressive hiking cycle since Paul Volcker.
Fed critics noticed the glaring discrepancy between Powell’s reluctance to engage and the December FOMC minutes, which contained an unusually explicit reference to the impact of market outcomes on financial conditions and the extent to which that nexus could work at cross purposes with policymakers’ inflation goals.
I talked quite a bit about this in “Easy Money,” but in the interest of underscoring the point, I wanted to point readers to the visual below, which gives you a sense of how Wednesday’s price action served to perpetuate the recent FCI easing.
Do take a moment to read the annotations. The context is important.
Recall that October’s cooler-than-expected CPI report triggered a massive one-day blast of FCI easing in early November. You’re encouraged to note that the stern December FOMC minutes (referenced above and released early last month), in part reflected a discussion at that meeting about November’s stock and bond rally, which was accompanied by a steep drop in the previously buoyant dollar. When Powell failed to push back during prepared remarks for a Brookings event on November 30, markets thought they saw a green light.
So, there’s a bit of Groundhog Day dynamic going on here, which is apt given that today is… well, it’s Groundhog Day.
But the real punchline (which I tried to spare readers, because it felt far too obvious), is that depending on which measure of financial conditions you consult, the Fed has in fact made no progress over the past year, despite 450bps of rate hikes.
“Some analysts question what measure Powell was referring to,” Vildana Hajric and Lu Wang wrote, of Powell’s remarks about financial conditions. Naturally, they referred to Bloomberg’s gauge which “sits today at a looser level than it was when the Fed began its tightening campaign last year.”
“Needless to say (but I will anyways, because that’s the kind of guy I am), my long-term ‘animal spirits’ / ‘pause-then-resume-hiking’ / left-tail scenario picked up meaningful delta yesterday, as Powell did almost exactly what I had expected, rolling with the same old tired hawkish rhetoric which the buyside has already looked past for the last three meetings,” Nomura’s Charlie McElligott said Thursday. He was referring to the thesis discussed earlier this week in “2023’s Most Mispriced Tail Risk.”
“A premature easing through this ‘loose FCI / animal spirits / wealth effect’ channel creates the potential conditions for a re-acceleration of inflation later this year… and just as global and domestic economies are already exhibiting tremendous resiliency and seeing a re-rating of growth higher,” Charlie went on. “And into a steroidal Frankenstein cycle, full of acts of God and man-made idiosyncrasies which have already caused overshoots in both directions multiple times over the past three years.”
Good one H…… The post with the second chart pretty well , when combined with the text confirms what I concluded although intuitively .. This clears it up thanks …again
I saw today that mortgages rates broke through the 6% level and are headed down to 5% unless conditions tighten again. Did Punxsutawney Phil see early signs of Spring for housing prices today?
My sense is that the BBG FCI index is sort of a measure of investor fear. The components are described here https://www.bentinpartners.ch/financial-conditions and consist of various spreads between risky and risk-free rates, option implied volatility indicies, and stock index level. When investors are afraid, spreads widen, implied volatility rises, stocks fall. When investors are UNafraid, the reverse happens.
As far as I can tell, the BBG FCI does not reflect the absolute level of borrowing costs. In principle, Treasury rates could be high and rising, and as long as spreads are narrow and vol is low, the FCI could be loose.
The Fed, on the other hand, appears focused on borrowing costs.
So I think I now better understand the gap between the Fed’s view of financial conditions and the street’s view. Yes, I may be the last person here to figure this out.
I still can’t believe this dude walked right into the worst case scenario…unless he’s playing 4D chess with the debt or Larry Fink told him he has a big problem on the balance sheet I just don’t get why he didn’t take another free verbal shot on the markets and set up a plausibly dignified opportunity to announce a pause at the next meeting. Have fun with housing costs reaccelerating. smh.
I was working an old farm house property today at the edge of town under an agreement with the lessee. A feller stops in the adjacent turning lane of a four lane street under moderate traffic and starts yelling (to beat the traffic noise) at me “hey can i buy this place”. I tried to tell him the ownership is a bank in New York City, but it didn’t work. I tried to tell him to use the appraisal district to get the contact information, that did not survive the language barrier.
Thank you for providing the ‘in the weeds’ analysis of what I’ve been perceiving about markets and tightening so far. Tech earnings are obviously telling the real story of the tightening impact which will force markets to start listening to actual data and not hopium from the Fed. But it does seem clear that everyone, even those not playing in the market, do not believe the Fed will continue down the tightening journey for long. The synopsis of 2023 looks very much like that of 2022 from the ‘experts’. Tightening will impact markets early but easing will lead to growth at the back half of the year. I don’t believe that 2023 prediction will prove to be any more reliable than the 2022 version did. And I agree that inflation is going to snap back higher in the spring because everyone is acting like it’s gone already, much like Covid after the first, 2nd, and 3rd waves.