The Fed will stay on hold this week. In a world plagued by terrifying uncertainty, that much is clear.
Or so markets were led to believe this month. Suffice to say it’d be an epic surprise if the Fed pulled the trigger on another rate hike at the November gathering.
By now, the September dot plot is stale. That’s not to say a December hike is out of the question, it’s just that Fedspeak in October overwhelmingly suggested the Committee has decided that, for now, the reals-led run up in long-end Treasury yields, and particularly the sharp term premium repricing, is doing enough to tighten financial conditions such that another rate hike, if it comes at all, can wait.
As ever, I’d remind readers that 25bps isn’t going to make the difference one way or another at this juncture. Either current policy settings are sufficiently restrictive to bring inflation back to target over time or they aren’t. If they aren’t, it’ll take a redoubled effort to remedy the situation, which is to say another full-on offensive, not incremental tinkering.
The market still assigns some odds to a hike across the December and January policy gatherings.
The figure above gives you a sense of how much additional buy-in the Fed won for the “high-for-long” narrative over the last three months. Note that the term premium repricing played out over the same three-month window.
Plainly, the incoming data suggests the US economy is holding up well. Spending remained strong in September and the Q3 GDP report showed the briskest pace of expansion in nearly two years. The PCE price overshoot is still substantial, and recent increases in home prices, not to mention the specter of higher crude in light of events in the Mideast, are upside inflation risks.
In addition, the legacy of the pandemic wealth effect, including and especially the home equity boom, continue to bolster spending. Paradoxically in the context of higher rates as a tool for cooling the economy, elevated rates on savings and money market accounts are likewise a boon to America’s “haves.” Money market funds alone are throwing off an estimated $20 billion per month in interest income.
Of course, all of this was known on October 19, when Jerome Powell spent an afternoon chatting with David Westin following a boilerplate address at The Economic Club of New York. The key message from the Q&A was that in Powell’s eyes, recent economic performance suggests policy isn’t too tight. Not exactly a groundbreaking observation (and indeed you might argue it’s just the latest example of the Fed’s penchant for driving through the rearview mirror), but it underscores the notion that Powell isn’t especially likely to put a dovish slant on November’s hold.
The proximity of the November meeting to the ECNY event limits the scope for Powell to deliver new information at the press conference — or at least the scope for Powell to deliberately deliver new information. There’s always a chance he’ll accidentally make news with an errant remark. While endeavoring to stick to the script, he’ll leave the door open to another hike, emphasize data dependence and allude to a more balanced risk asymmetry, even as he’ll reiterate that inflation remains the bigger threat, particularly given scant evidence of an imminent turn in the labor market.
“Powell has no incentive to signal a shift away from the wait-and-see messaging,” BMO’s Ian Lyngen and Ben Jeffery said. “The Fed has been leaning heavily on the fact that higher nominal Treasury yields are an effective form of tightening overall financial conditions [and] this logic will be reiterated on Wednesday, lead[ing] to the obvious question of how the Fed would respond in the event of a Q4 Treasury rally that counteracts the tightening impact of higher rates.”
Elsewhere, the Bank of Japan meets this week. In all likelihood, they’ll keep policy settings unchanged, but there’s a small chance of another yield-curve control adjustment.
This is the same story over and over again. Whenever 10-year JGB yields are at or near the ceiling, the risks to the yen are twofold: The BoJ prints money to defend the yield cap (so, easing), and because upward pressure on JGB yields tends to coincide with rising Treasury yields, rate differentials tend to move against the yen (because JGB yields can only rise so far).
The yen is flirting incessantly with 150. The BoJ adopted a more flexible approach to YCC in July in an effort to establish a kind of pressure valve, but it’s of little use in an environment where the US long-end is selling off inexorably.
In the event the BoJ were to abandon YCC, market participants would expect more pressure on long-end US yields. The artificial suppression of JGB yields helped spur demand for foreign fixed income given the dearth of yield available at home to Japanese investors.
If the BoJ announced another tweak (where that means giving JGB yields more room to run higher), the timing would leave something to be desired: The BoJ decision lands between Monday’s Treasury refinancing estimate and Wednesday’s refunding announcement. Given the perilously combustible situation in Treasurys is a function of oversupply concerns exacerbated by pressing sponsorship questions, a BoJ tweak this week is a risky proposition.
Finally, the beleaguered BoE will probably keep rates on hold. The data is hopelessly inconclusive. Inflation remains far too high, but the risk of recession is likewise elevated. There’s no consensus on the MPC, or at least not judging by the September vote split. The bank will release a new set of forecasts alongside the policy decision. If nothing else, those’ll be good for some comic relief.
The political implications of the stagflationary macro backdrop in the UK are quite pressing for Rishi Sunak. The Tories are in a bad way.
The latest YouGov polling showed general election voting intentions skewed towards Labour by a 24ppt margin.
For those still inclined to apologize for Liz Truss, note that the spread was 8ppt prior to her short stint as Prime Minister. It ballooned to 36ppt during the worst of the October 2022 gilt crisis and has never been narrower than 13ppt since.
