“Markets took the change in guidance as an ‘all clear’ sign to ramp up risk further,” Morgan Stanley’s Mike Wilson wrote Monday, reflecting on the December FOMC meeting and Jerome Powell’s press conference, during which the vaunted Fed chair evinced no inclination to lean against the rollicking “everything rally” which served to ease US financial conditions in recent weeks.
In contrast to the Fed’s many critics who generally insist Powell is now risking an inflation re-acceleration by countenancing a rekindled wealth effect, Wilson pointed to “micro” data which he said suggests inflation “is even lower than the headline statistics.”
Among other things, he cited goods deflation, weak commodities and “anemic” Q3 earnings which, he noted, stood out “in the context of an economy growing close to 9% nominally.”
Wilson spent months this year commenting on the read-through of rapidly receding producer price growth for corporate revenues. Producer prices, he reiterated on Monday, are a much better barometer than consumer prices when it comes to assessing the operating environment for corporates.
The simple figure above is familiar to anyone who follows Wilson’s work. “The fact that the YoY change in PPI is already in negative territory helps to explain why sales and EPS growth have been weaker than economic growth,” he wrote, before wondering if “perhaps the Fed has noticed this dynamic.”
Crucially, the Fed will be cutting rates before inflation has returned to 2% on a sustainable basis. Powell made that much clear last week, although he’d say the key point isn’t whether inflation is 2% at the time of the first cut, but rather whether officials are convinced it’s on its way there when the policy rate is reduced. Whatever the case, there’s some tension between the idea of reducing the amount of policy restriction prior to the achievement of 2% and the Committee’s deliberately overwrought (and, as a result, somewhat unconvincing) pretensions to restoring price stability at all costs.
Bottom line: The de facto single mandate that existed since March of 2022 is no more. We’re back to the dual mandate now, and that entails a renewed focus on sustaining some baseline level of healthy growth, perhaps at the expense of the proverbial “last” inflation “mile” from, say, 3% core price growth back to 2%.
The good news is, the market doesn’t yet see a policy mistake vis-à-vis inflation even if Fed detractors do. Thank falling oil prices if you like, but whatever the cause, breakevens aren’t just steady, they’re near the lowest levels in three years.
Reals have, of course, moved markedly lower as traders price Fed cuts. That’s a very favorable backdrop for equities at the current juncture.
“Given that policy rates (both nominal and real) are well into restrictive territory, the Fed likely doesn’t want to wait to shift to a more accommodative policy until it’s too late to achieve a soft landing,” Wilson said Monday. “This is a bullish outcome for stocks because it means the odds of a soft landing outcome have gone up if the Fed is going to start focusing more on sustaining growth rather than worrying so much about getting inflation all the way down to 2%.”
Although he said there’s some risk that a dovish shift could indeed reawaken the inflation impulse “down the line,” for now, the return of a more normal balance of risks in the Fed’s decision calculus (i.e., growth getting some serious “weighting” for the first time in almost two years) is “welcome news to equity investors.”
That’s “especially” true considering the “bond market’s reaction to the dovish guidance,” Wilson went on, adding that with “inflation breakevens remain[ing] well-behaved and bond yields fall[ing] further as more rate cuts get priced in, markets seem of the view that the Fed isn’t making a policy mistake.”
Is this a mea culpa from Mr. Wilson, or is he sticking with his bearish forecast?