The past six weeks were defined by growing conviction in Fed rate cuts. Although that conviction might be shaken by a stronger-than-expected US jobs report, it’ll take a re-acceleration in realized inflation and a (much) more assertively hawkish cadence from Jerome Powell to truly dissuade wagers on a lower policy rate as soon as the March (or May) FOMC meeting.

Softer data played a big role in the rates about-face witnessed since late-October, but Chris Waller’s remarks on November 28 were pivotal — his comments were the clearest indication yet that policymakers are inclined to cut rates in 2024 regardless of whether the economy is decelerating, assuming inflation continues to moderate “on schedule,” so to speak.

The rationale is simple and, I hope, familiar: If inflation continues to recede and the Fed keeps rates where they are, the real policy rate will become mechanically more restrictive in a kind of “passive” tightening. That isn’t necessarily desirable, particularly if it’s happening against a backdrop where the “long and variable” lags are starting to manifest in a softer labor market and slower consumption.

So, “insurance cuts” to prevent mechanical tightening — “cutting to stand still” in the context of the real policy rate. That’s “the Waller doctrine” as one popular derivatives strategist put it earlier this month.

As I wrote on November 29, it was hard to overstate the significance of the apparent tone shift from the Fed regarding the prospects for rate cuts in 2024. Maybe Powell will try to walk it back next week, maybe he won’t, but it’s important to note that “insurance cuts” were always on the table. Officials haven’t made a secret of their prospective willingness to cut rates. Waller’s remarks simply introduced a broader set of market participants to the idea of rate cuts without a recession.

The implications for the front-end were dramatic and shifted the rates vol zeitgeist. “The Waller doctrine shocked markets into a new distribution and accelerated the timing of the Fed’s policy easing path,” Nomura’s Charlie McElligott wrote earlier this week, noting that “legacy ‘short’ upper-left versus ‘long’ upper-right customer positioning got sucker punched thanks to this new mode of the policy easing tail.”

I talked at length last week about Waller freeing up the front-end to move. McElligott underscored the point. “The policy-sensitive upper left has seen vols squeeze sharply, while intermediates and longer-dated right hand side sit relatively calm.” (Note the timeframe on the visuals below: From November 27 through December 6.)

The action in short-end vol might’ve contributed to the wave of unwinds and monetization seen across the USD rates space. The vol expansion may have pushed popular positions “through risk budgets, forcing size reduction,” Charlie said.

On Friday, following the warm jobs report in the US, the curve bear flattened as rate cut bets were trimmed. That’s a reversal in terms of directionality, but it’s more front-end-centric fireworks.

Notwithstanding the robust jobs release, markets are still looking at high odds of multiple Fed cuts in 2024, even as traders were inclined to push the timing of the first cut out a bit in light of the payrolls beat (i.e., March odds were faded, leaving the May meeting as the likely first cut). What does that mean for asset prices in general?

Well, it depends. “Asset prices around the first Fed rate cut are very dependent on the reasons the Fed is cutting,” BofA’s Michael Hartnett said, in his latest.  There are “no hard and fast rules,” he wrote, before generalizing a bit about a dozen “first cuts” looking back half a century.

“When the first Fed cut precedes a recession, it comes after three months of falling oil prices and an inverted yield curve” and typically “triggers lower Treasury yields, a stronger dollar and lower US stocks,” he wrote. “This is the situation today.”

Hartnett described other “kinds” (so to speak) of first cuts, using the table shown above as a guide. Frankly, I doubt there’s much to be gleaned from analyzing prior “first cuts,” but that’s not going to stop anyone (and everyone) from trying.

This sort of analysis should be contextualized by the prevailing macro regime and specifically by inflation. The standard narrative says the Fed will be reluctant to cut in 2024 given the PTSD from the 2021/2022 inflation shock. It’s worth asking whether that has it backwards: They may be quicker to cut in 2024 given the possibility that the rapidity and scope of the hiking cycle raises the stakes in the event policy isn’t nimble enough as inflation falls and the labor market softens.

Although I’m sympathetic to the idea that the financial conditions transmission channel functions more efficiently than it once did (and that it might therefore make sense to suggest the lags aren’t as “long” as they used to be), it’s well established that households and corporates were more insulated this cycle from rising rates. Although the variable-rate share of household debt is quite low, and while the largest US corporates termed out their debt profiles, the bill for a “high for longer” policy stance will come due eventually in the form of rising delinquencies (not on mortgages, but on other sorts of debt) and bankruptcies, refi walls for smaller firms and, crucially, tight credit conditions for small businesses.

All of that to say that cuts are coming in 2024, likely against a background of additional inflation moderation. That’s the “Waller doctrine.” The question for market participants is how quickly the labor market turns. The November jobs report suggests there’s still significant runway but… well, “no one rings a bell,” as they say.

“[It’s] all about the US labor market, and the labor market remains the decisive soft versus hard variable,” Hartnett wrote. “Hiring is slowing, but as yet there’s no firing. The growth of temp workers [is] close to the recession threshold, and there’s much focus now on the Sahm Rule,” he went on, adding that markets “sold the last hike from July through October.” Now, traders are “front-running the first negative payrolls print and the first Fed cut.” “Stage three,” Hartnett said, “is another reversal once the data unambiguously shifts from soft to hard.”