‘Increasingly Confident’

If the Fed’s concerned about their financial conditions reflexivity predicament, they aren’t showing it.

Chris Waller on Tuesday said he’s “increasingly confident that policy is currently well-positioned to slow the economy and get inflation back to 2%.”

Waller’s remarks, during a speech at the American Enterprise Institute, were (correctly) interpreted by markets as confirmation that the Fed’s done raising rates. Not that anyone needed confirmation. Additional hikes were all but priced out earlier this month.

Although he didn’t completely rule out raising rates again (the Fed has to retain the pretense of two-way policy risk), Waller described himself as “encouraged” by the incoming data. “Something appears to be giving,” he said. “It’s the pace of the economy.”

Waller, like his old boss Jim Bullard, is a born-again hawk — an erstwhile dove who changed his feathers during the post-pandemic inflation fight. If he’s satisfied that terminal is achieved, it’s a strong nod to the idea that the bar is quite high for another rate increase.

Some commentators pointed to offsetting remarks from Michelle Bowman, but nobody parses Bowman. She’s nominally important, but she isn’t a bellwether. Besides, her Tuesday remarks included a caveat of sorts. “I remain willing to support raising the federal funds rate at a future meeting should the incoming data indicate that progress on inflation has stalled,” she said in Salt Lake City, after reiterating her ad nauseam contention that another hike will probably be necessary. The conditional nature of her assessment counted as conciliatory, and pretty plainly suggested she’s under (very mild) pressure not to come across as completely out of step.

Importantly, Waller alluded to insurance cuts in 2024 for the purposes of ensuring the Fed doesn’t tighten passively through the real policy rate channel as inflation recedes. “Nothing to do with trying to save the economy or recession,” he remarked. “If we see disinflation continuing for several more months… you could then start lowering the policy rate just because inflation’s lower.”

In the context of insurance cuts and the December SEP, it’s important to note that if the Fed doesn’t hike next month and the median 2024 dot doesn’t shift, they’ll be removing a rate cut. The September dot plot tipped 50bps of cuts next year, but from a higher terminal rate which now looks very unlikely to be achieved. So, if the 2024 dot doesn’t move lower, Jerome Powell will need to somehow reconcile the notion of just one rate cut in 2024 against market expectations for ~four, but more importantly, against expectations for meaningfully lower core inflation.

“Given the September SEP dots showed the 2024 year-end policy projection at 5.1%, unless that’s revised lower the Fed will in effect take out another rate cut from the 2024 forecast, a stark contrast from the ~100bps of rate reduction the market is pricing in through January 2025,” BMO’s Ian Lyngen and Ben Jeffery wrote, adding that they can “certainly see the appeal of the logic that if the Committee chooses to lower its terminal ambitions, it can at least aspire to keep terminal in place for slightly longer than previously signaled.”

That may well be appealing to the Fed, but it won’t be appealing to markets. If core inflation continues to fall, it’ll be very difficult for the Fed to square the circle between consistent messaging from officials (like Waller on Tuesday) about cutting to prevent the real policy rate from rising mechanically and telegraphing just one 25bps cut for the entire year. There’s too much cognitive dissonance there, and the market simply won’t bear it, particularly not if Fedspeakers continue to explicitly nod to insurance cuts in public remarks.

Contrary to the musings of a terminal blogger or two on Tuesday, I see no reason for the market to pare back expectations for 100bps of cuts in 2024. Two insurance cuts to keep up with falling inflation gets you halfway there already, and that doesn’t count any cuts aimed at short-circuiting nascent risks to the labor market or any type of insurance the Fed might take out in the event of exogenous shocks.

Of course, the problem is that no matter how rational expectations for rate cuts in 2024 might be (or at least might sound), those expectations can feed irrational overshoots in asset prices in the meantime, which is where the financial conditions reflexivity comes in.

Coming full circle, Waller did at least acknowledge the financial conditions feedback loop, although it’s pretty clear the Fed thinks the disinflation process is entrenched in the real economy such that any rekindled wealth effect from financial asset appreciation likely won’t derail things.

“The recent loosening of financial conditions is a reminder that many factors can affect these conditions and that policymakers must be careful about relying on such tightening to do our job,” Waller said.


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2 thoughts on “‘Increasingly Confident’

  1. If tighter FCI can stand in for the final rate cut, then perhaps once-and-future looser FCI conditions can stand in for a future “insurance cut” or two. Of course for that to work, FED speakers would need to absolutely not say that part out loud.

  2. The Fed has become so obsessed about wrong-footing the markets with Powell’s push towards greater transparency and guidance (speaking), that now the markets seem to be able to increasingly wrong-foot the Fed. I wish the Fed collectively would quiet down and ignore “squaring the circle” on an ongoing basis. As it stands, it feels like we’ve reached a point that “markets” feel they know what the Fed will do and when better (or at least with more certainty and precision) than the Fed itself does. Maybe a little less certainty and a little more Fed volatility is the tonic.

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