‘No Meaningful Conviction’

Market observers employed hopelessly outdated colloquialisms to describe subdued sentiment at the beginning of the first full trading week of December.

Canaccord’s Tony Dwyer, for example, told Bloomberg Television that after November’s raucous rally, equities may need to “chillax.” Really takes you back — to Wayne Campbell’s basement.

What needs to “chillax” (indeed, what almost has to chillax) is rate cut pricing for 2024, which frankly can’t get any more dovish without evidence to suggest the US economy is approaching a so-called “Wile E. Coyote” gravity moment.

I’ve been over this at length, but it bears repeating. The 2024 dot almost has to shift lower in the updated SEP next week assuming, of course, the Fed doesn’t hike. The September dot plot telegraphed 50bps of cuts next year, but that was from a higher terminal rate which is now very unlikely to be achieved. So, if the 2024 dot doesn’t shift lower, the Fed’ll be projecting just 25bps worth of cuts against market expectations for 125bps.

That’s too much tension, in my view, particularly in the context of the Fed’s insistence on i) the notion that last year’s tightening hasn’t yet fully manifested in the economy and ii) the Committee’s avowed intention to preside over additional labor market softening, even as lost jobs aren’t a policy goal, by rather a means to an end. The new SEP will almost surely telegraph a higher unemployment rate than what Friday’s jobs report is likely to show (even if the Fed’s forecast still won’t come anywhere near 4.5%) and should also reflect expectations of additional disinflation.

Taken together, all of that will demand a downshift in the 2024 dot, unless the Committee wants to chance a sharp reset higher in front-end rates and the aggressive paring of rate-cut bets for next year. I don’t think they necessarily want that, notwithstanding any mild discomfort with the recent FCI easing.

But, as alluded to above, officials surely don’t want the market pushing the rate cut envelope much further than it’s already been pushed either. “Embedded within the forward path of policy rates suggested by the futures market is the notion that the realized data will continue cooling and Jerome Powell will quickly respond with cuts to ensure the deceleration doesn’t turn into a recession — that much is evident even to rates strategists,” BMO’s Ian Lyngen and Ben Jeffery joked on Monday.

I argued late last week that Powell’s remarks at a December 1 event in Atlanta should be interpreted dovishly, which is to say the market reaction was entirely consistent with Powell’s nuance. Some observers seemed to disagree with that assessment, where that means much of the commentary I read over the weekend and into this week suggested the front-end (and equities) rallied “in Powell’s face,” so to speak, despite his best efforts to dissuade overzealous traders. I wish there were a more polite way to say this, but: That simply isn’t right.

Recall that Powell kickstarted this during the November press conference when he said, in response to a question from Bloomberg’s Michael McKee, “Many things could change that would cause people to change their dot. The efficacy of the dot plot decays” over the three-month period between SEP meetings. That was, arguably, a mistake.

“It is important to remember it was key upward revisions in the September dot plot that finally convinced markets the FOMC was sincere in its ‘higher for longer’ outlook,” JonesTrading’s Mike O’Rourke pointed out on Monday. “The market interpretation was that the Chairman stated September’s hawkish dot plot was no longer valid,” he added.

When taken with a run of soft macro data and relief at the long-end of the Treasury curve engendered by smaller-than-anticipated coupon increases in the November refunding announcement, markets had the green light. In the same note, O’Rourke correctly diagnosed the problem. “Market easing expectations have run wild [and] Powell has done little to dissuade the market from its excited interpretation,” he wrote. “It is something Powell does frequently when markets are running — he says just enough to provide policy optionality, but has no meaningful conviction behind his statements. Friday was another example of this.”

Regular readers will note I’ve said something very similar on innumerable occasions, including on November 2, when I wrote, of last month’s FOMC press conference, “While Powell insisted that the Fed is indeed still considering an additional hike, he also said the dot plot’s relevance tends to decay in the three months between one vintage and the next. Markets (quite rationally) took that as additional evidence to support the notion that rate hikes are likely finished.”

This habit of Powell’s continually puts him behind various eight balls, and the final FOMC presser of 2023 will be no exception. The new SEP (inclusive of the dots and the updated projections) has to represent a happy middle ground between aggressively dovish market pricing and the Fed’s (by now wholly unbelievable) pretensions to two-way policy risk.

I don’t know what that middle ground looks like and neither does Powell. One potential problem is that with the market leaning so emphatically dovish, it’d take an overtly hawkish hold to disabuse traders, and that’d risk a self-defeating market event (i.e., a correction deep enough to compel the very rate cuts the Committee was trying to delay).

On the other hand, “When you are a bull, everything looks like a red cape,” as Cameron Crise noted late last month, which is to say the market is ready and willing to read Powell dovish regardless of what he says. “From our perspective, the Fed hasn’t really changed their guidance all that much over the last six months,” Morgan Stanley’s Mike Wilson said Monday. “But the bond market’s view is what matters.”