There was more than a little perturbation Thursday among the Fed’s legions of critics.
With the US economy still performing well (as far as anyone knows) and core inflation still double target, the idea of an overt dovish turn was anathema for market participants with a penchant for Fed contempt. For that contingent of observers, Jerome Powell’s press conference performance was nothing short of a travesty.
“The absence of intellectual honesty is astounding. The inconsistency maddening,” JonesTrading’s Mike O’Rourke despaired, charging Powell with “duplicity” for seemingly contradicting the more strident cadence he adopted during a late-October chat with David Westin at the Economic Club of New York.
“If Powell and his colleagues did not realize that the market reaction to [the dot plot] would be a further easing of financial conditions following the record easing in November, they should find a new profession,” O’Rourke went on.
To be sure, the combination of the three cuts tipped by the dots and Powell’s “failure” to play bad cop during the press conference did indeed ease financial conditions further. And markets pushed the envelope on rate cut bets.
On Thursday, rate-cut pricing for 2024 nearly reached 160bps, almost 50bps more than the market priced in the hours leading up to Wednesday’s statement, SEP refresh and Powell’s press conference.
10-year reals were well below 2% amid the dovish escalation (which saw five-year reals drop 23bps on Wednesday in the wake of Powell’s presser). Note that the decline in reals is directly related to multiple expansion for equities. That’s the risk asset transmission channel.
Naturally, many market observers were keen to marvel at the one-day easing impulse on Goldman’s US financial conditions index. As the figure below shows, Wednesday’s easing was on par with that triggered by the benign October CPI report and, before that, the potent mix of smaller-than-expected coupon increases in Treasury’s quarterly refunding announcement, an ISM miss, Powell’s remarks during the November FOMC press conference (when he said the efficacy of the dot plot “decays” between SEP meetings) and a soft October jobs report.
When asked during this week’s press conference about the ebb and flow of financial conditions as measured by the indexes often cited by market participants, Powell described a “see-saw.” Apropos, Goldman’s gauge has now erased the entirety of the tightening seen from late-July.
You’re reminded that the new blast of FCI easing comes on the heels of what was already the third-largest 30-day easing of the COVID era, again using the Goldman gauge.
“There has been a reasonably well-held view that the Fed might get worried that financial conditions were easing too much with this rally in bonds and equities, and so might be motivated to push back on this a bit if only to prevent financial conditions ultimately undermining progress on disinflation,” Deutsche Bank’s Tim Baker said, in remarks quoted on the terminal. “But ultimately we got no response to any of that from the Fed.”
I want to make two points about all of this. First, it’s absolutely true that there seems to be a kind of double standard at the Fed when it comes to financial conditions. If they’re tightening (as they were from August through October), that’s an excuse to skip a rate hike. But if they’re easing (as they were from November through mid-December) that’s not an excuse to push back, let alone to raise rates as a counterbalance. Relatedly, the Fed has, over the past several decades, stepped in to rescue equities, but policy never seeks to actively undermine stocks. Again, there’s a double standard. And yet, there’s something to Powell’s contention that the Fed can’t conduct monetary policy through Wall Street’s financial conditions indexes. The Fed has a mandate, and that mandate doesn’t include actively managing any sell-side FCI gauges, or even the Fed’s own FCI measures.
Second, if we’re being completely honest, the idea of rate cuts in 2024 to ensure the real policy rate doesn’t rise mechanically as inflation recedes isn’t new. John Williams telegraphed it months ago. Powell has alluded to it on several occasions. All Chris Waller did late last month was bring it to more market participants’ attention. The dot plot simply reflected those risk management cuts.
While I’m sympathetic to the notion that the Fed may be insufficiently attentive to the read-through of easier financial conditions for the “last mile” of the inflation fight, critics appear to be suffering from a bit of selective hearing: The Fed telegraphed the cuts it tipped on Wednesday in August when Williams told The New York Times‘s Jeanna Smialek that “Assuming inflation continues to come down… if we don’t cut interest rates at some point next year then real interest rates will go up, and up, and up, and that won’t be consistent with our goals.” Regular readers may recall that I pushed back on that notion at the time, but the point here is just that the Fed didn’t make a secret of this. Some people just weren’t listening, or else didn’t like what they heard and so chose not to incorporate it into their expectations for Fed communications.
Ultimately, the key is that recent developments suggest a soft landing may no longer be a long shot. Maybe it still isn’t the most likely outcome, but the odds have doubtlessly improved. That’s not lost on the Fed, and as concerned as they surely are about an inflation re-acceleration, it’s important to remember that driving with the rear view mirror is what put them behind the macro curve in the first place. To the extent the insurance cuts tipped by the dot plot (and Powell’s reluctance to push back on market pricing for an even more aggressive risk management approach in 2024), represent the Fed trying to make policy by looking ahead rather than behind, you could argue that’s a positive development. Whether it has the deleterious side effect of rekindling inflation through the wealth effect channel remains to be seen.
I have to believe the Fed went into Wednesday’s release and presser with their eyes open to the impact it would have on markets, and they were clearly okay with it. That suggests they wanted a very mild form of easing, presumably to maximize the glide-path available for a soft landing. Sully never wanted to be in a position to have to execute an emergency landing with a plane full of passengers, but the Hudson River did offer the major advantage of being a really long runway, giving him the room and time he needed to maneuver into a perfect splash-down. After all, the real impact of easing financial conditions on the inflation and the economy will be negligible in the very short term, and minimal in the medium-short term. To the extent lower 5 years (or whatever) helps a business clear their hurdle for new investment, that still takes months to a year+ to manifest in real activity. It’s unlikely any family will change their holiday spending plans tomorrow in consequence of a 5% bump in the Russel 2000 today. At this point, easier FCI just means the Fed’s hand isn’t forced into a QT wind-down or “insurance” rate cut sooner than they’d like. A longer glide path = more flexibility to be a supplier of convexity when it’s needed most. And it’s an election year…
I think the Fed has done a pretty good job steering through a pandemic/post-pandemic period that has befuddled everyone’s models. A good part of the inflation surge was indeed transitory (supply chain-driven goods shortage, virus-driven labor shortage) and a good part was fueled by the government’s pandemic measures (stimulus in never-before-seen quantity). No economic model was capable of forecasting the weirdness on the last four years, so the Fed rightly dropped its models and started vigorously ad-libbing aka data dependency.
The economy has remained strong, inflation is coming down, and the Fed may well manage to grease the landing. One can debate how much has been pilot skill and how much has been luck + circumstance, but isn’t that always the case?
Powell has his issues as a communicator, and the FOMC in general talks too much, but he appears to be able to lead and manage the committee and, I suspect, commands significant respect from its members.
I think derision is unwarranted, and that the peanut gallery are a mostly bunch of, well, peanuts. I also think the Fed chair is not required to publicly conform to some predictable logic of decision-making or be bound by prior statements – he can change his mind and needn’t apologize for wrong-footing the peanuts.
But I think there is room for us peanuts to feel some some discomfort and worry. It is not clear that policy is actually restrictive, despite the FF-CPI spread – ref back to models not working. It is not clear that the hard core of wage-driven inflation has actually been broken, with as many still-hot labor market data points as there are cooling data points. It is not reassuring to see yield curves re-inverting and term premiums negative, and I struggle to find attractiveness in 4% long yields.
Regardless, my (or anyone’s) agreement or disagreement with Fed policy is pretty irrelevant. The FOMC has pivoted hard to dovish, it is what it is. If we were wrong-footed and lost money in the last two days, tough luck. We should focus on what to buy and sell.
The last 24 hrs have been good for my positioning, and the stuff I need to buy now are mostly things I wanted to buy anyway, so time to buckle down and do the work.
Well said, sir.
Mmmm. I wonder if some folks at the Fed are quietly waking up to the idea that raising interest rates had only a limited impact on inflation. With outsized collateral damage.
Such as making housing unaffordable for most Americans. As JL noted, their models could not cope with the idea that higher rates would discourage sellers rather than buyers.
Powell and his colleagues were late in recognizing pandemic inflation as a problem; everyone gets that. But once he and they did, they’ve done a darn good job in catching up. As for his style of communication? I might be the only person in America who thinks this, but I think Chair Powell has been just what we needed in this particularly fraught moment in our history. Overall, I give him an A-.
+1. You’re not the only person . . . except I’d given him an A+. He has an impossible job.
For a take on what’s behind the Fed shift, see David Rosenberg’s piece today “The Fed Just Woke up and Smelled the Recession”
Did the Fed betray a hint of concern about recent data? Perhaps not just data of the economic variety but also of the presidential poll variety? They are human after all, they may be apolitical as well, but if a group of technocrats has an interest in not seeing a return of the Don the FMOC is near the top of the list (can’t blame them). Perhaps the combo of economic deceleration, declining inflation and rising poll numbers for Trump is reason enough to pivot now in dovish fashion.
I suspect there’s something to that, and shame on me for not factoring it in.