This time last month, US financial conditions, as measured by various Wall Street gauges, were setting up for one of the more dramatic easing impulses in recent memory.
The tide was already turning courtesy of Treasury’s polite nod to supply concerns in the refunding announcement and a (relatively) soft jobs report, but the real fireworks began on November 14, when a favorable October CPI update triggered exaggerated dovish price action reminiscent of the reaction to the October 2022 CPI report.
Fast forward a month and the latest inflation update out of the US (i.e., November CPI) was mixed, leaving the macro narrative mostly unchanged ahead of 2023’s final FOMC meeting.
As discussed at some length in my Fed preview, last month’s dramatic FCI impulse looms large over this week’s policy gathering. As the figure below from Nomura’s Charlie McElligott shows, the last 30 days saw the third-largest FCI easing of the entire pandemic era on Goldman’s widely-cited gauge.
“The easing of US financial conditions has been an absolute whopper,” Charlie wrote. “The perception of high-delta ‘soft landing cuts’ seemingly fatten[ed] the ‘immaculate disinflation with no hard landing’ right-tail, which fed the ‘everything rally.'”
He was referring, of course, to the combination of softer data and Chris Waller’s November 28 discussion of rate cuts for risk management purposes (i.e., “nothing to do with trying to save the economy or recession,” as Waller put it, but rather rate cuts “just because inflation’s lower”).
As McElligott went on to note, Jerome Powell had a tough balancing act on his hands this week. Presumably, there’s some inclination on the Committee to push back against the FCI easing, particularly given how much emphasis the Fed placed on financial conditions when telegraphing their intention to skip the final rate hike tipped by the September dot plot. And it was highly unlikely (bordering on the impossible) that the dot plot refresh this month would match market expectations for four (and then some) rate cuts in 2024. But unless the Fed wanted to convey less confidence in the price growth trajectory despite demonstrable progress towards target, the new projections were set to reflect more faith in a good inflation outcome.
“[The] potential for conflicted messaging into the final Fed meeting of the year is high,” McElligott wrote, describing “an unenviable and potentially incoherent position” wherein the Committee needs to “jawbone FCI tighter after the recent easing at the same time their dots might not match market expectations [for] relatively deep cuts next year,” even as the SEP might “nevertheless show a dovish tilt reflecting slowing growth momentum and an accelerated disinflationary trajectory of late.”
More generally, officials have gingerly begun to emphasize the favorable disinflationary trend at the incremental expense of the “vigilance” talking point (notwithstanding the extra hike Michelle Bowman would implement overnight if she were a one-woman committee). Powell will be adamant about “finishing the job,” but he surely doesn’t want to contradict the idea that things are moving in the right direction. No matter how worried you might be about a counterintuitive FCI easing, you don’t want to completely downplay hard-won progress.
“Anecdotally, I’d say many are expecting some sort of incrementally less-dovish message due to [the Fed] needing to push back against the recent FCI easing, but how does the Fed not highlight the inflation decline as it relates to what’s almost certain to be a dovish tilt [in the] economic projections?” Charlie asked. “Otherwise they’ll have to turn on a dime in next year’s early meetings.”
Powell and company are not going to do anything to jeopardize a soft landing. They’ll keep the funds rate at these levels longer than the markets think they will.
Super-core (services ex-shelter) is running around +6% annualized and not yet in a clear declining trend. Employment and wage data are not clearly cooling down. The rent component of shelter inflation is declining and seems likely to continue declining in 2024 (based on supply), but the much larger OER component is declining but seems at risk of reaccelerating later in 2024 (based on lagged home price data). Energy deflation may be running out of gifts to give, with both oil and crack spreads not far off their 3 year lows. Goods deflation does seem sustainable, with China helping out. Overall, I think hawks on the FOMC still have to worry about finishing the job, while it is hard for me to see what economic pain doves can really claim compels easing now.
I forgot to add – the FOMC seems to be undecided if it will be model-driven or data-driven. It wasn’t so long ago that the FOMC was acknowledging that models weren’t working and vowing to be guided by data. Now people are dredging out the “Taylor Rule” to argue that rates must be cut and now? If I recall, last year the Taylor Rule was prescribing FF in the 7-8% range.
There is also not one “Taylor Rule”, but many versions which give a range of prescriptions. Here is an interesting way to generate Taylor Rule charts using various different versions of said rule.
https://www.atlantafed.org/cqer/research/taylor-rule.aspx?panel=1&s=blogmb
Defintely seems to be a number of FOMC members who would like to move toward a more rules-based model, though one less rigid than the model Taylor has long advocated (which is why, imo, his model has never been widely embraced).
IIRC, Prof Taylor himself warned that his model might not be 100% applicable when a large extraneous event occurred. Like an earthquake or, ah, even a pandemic?
Jeez JL, I do hope that they opt to be data-driven. Models keep proving to be only mildly useful in relatively calm times but useless when “low probability” events shake the built in assumptions. Like three one-in-a-hundred-year storms hitting an area in five years or there’s a pandemic or something.
I cannot understand why anyone would put much credence in static-equilibrium-based economic models in our new world of larger-than-normal geopolitical and climate-change-driven risks.
(Many hyphened terms there. They must make our Dear Leader shudder…..)
Model-led is hubris, data-driven is humility, the Fed may be feeling tentatively rather good about itself but I also hope humility is not cast aside. The last few years have broken many models, the Fed shouldn’t think its models are self-healing.
On the nose, sir, as with your comments above.
I hope someone asks Powell if FCI is truly a two way street. The Fed is on record saying a demonstrably tighter FCI could stand in for a policy rate increase (last meeting). If that’s the case, and the underlying macro is largely unchanged, then why wouldn’t a comparably looser FCI spur a policy rate increase? Are some components of financial conditions (equities) less important than others to the Fed’s assessment re their policy rate?