Did they cancel the recession again? Or are market participants just confident in the Fed’s capacity to manage the burgeoning slowdown?
I don’t know the answers. But I do know the risk tone on Wall Street improved markedly in recent days (choppy price action aside), with investors’ spirits buoyed on Tuesday by a softer-than-anticipated read on US producer prices.
The fear headed into this week was (and I suppose still is pending CPI) that inflation updates out of the world’s largest economy might close the door to, or at least raise the bar for, a dovish first cut from the Fed at next month’s meeting.
Barring some manner of anomalous re-acceleration in consumer prices, the Fed’s going to cut next month. It’s just a matter of how much and how it’s packaged (i.e., what the forward guidance and dot plot convey about the balance of the year). A 50bps move looks a lot less likely than it did just a few days ago, but it’s still possible and anyway, a 25bps cut could be accompanied by a dovish dot plot in the event the data evolves in a such a way as to perpetuate the growth concerns behind the early-August vol shock.
But not if inflation refuses to cooperate. Upside surprises on that front wouldn’t take a 25bps cut off the table, but they would prevent the Fed from going too dovish on the forward guidance, and that could be a problem in the presence of a sharp deterioration in the growth outlook. In short: If a sharp slowdown’s in the offing, you don’t want a monetary authority hamstrung by stubborn inflation.
Importantly, a Fed that doesn’t cut meaningfully — and soon — is a Fed that runs out of goodwill, not just with front-end rates (which are screaming at Jerome Powell to move) but with investors more generally, who overwhelmingly view current policy settings as too restrictive.
The figure above is (obviously) from the August installment of BofA’s Global Fund Manager survey and although it speaks for itself, I’ll say a few words on its behalf: A larger share of professional money managers view global monetary policy as too restrictive than at any other time since October of 2008, which is to say since the days after Lehman collapsed.
It’s that belief — or, more to the point, the belief that policymakers “get it” — that’s preventing a wider market conflagration in the presence of the US growth scare. That’s another way of saying faith in the “policy put” is still quite strong.
“Investors’ belief that policymakers must ease rapidly [is] driving expectations for lower rates,” BofA’s Michael Hartnett wrote, editorializing around the survey results.
The figure on the left shows those expectations. More than nine in 10 — so, everybody, basically — expects lower short rates from here.
That’s the highest in at least a quarter century, and the assumption that policymakers will deliver is behind record conviction in a soft landing, Hartnett went on.
What happens if the Fed doesn’t deliver? That is: What happens if Powell doesn’t “fix” the situation illustrated in the first chart above and do so expeditiously?
The figure on the right in the second set of charts answers that question: A US recession overtook geopolitics as the top tail risk this month.
Let’s consider what we can say about the Powell Fed with high confidence:
1) They hate causing surprises. When inflation data released during the communication blackout period suggested matters were more urgent than originally thought, they didn’t just up the hike at the next meeting, they got Nick on the phone and had the WSJ leak the move.
2) They over communicate. That’s been discussed here plenty of times.
Add those two things up, and you can be damn sure we’ll know the exact size of the September cut well before the FOMC meeting even starts.
Another thing one could say about the Fed: It and Jay Powell have lots of tools at their disposal but there is only so much they can do to micro-manage a $29 trillion economy that also happens to be the linchpin of the global economy, with all that entails. Jay Powell is not perfect, but fwiw I think he’s the best Fed chair since Volcker.
I have had just about enough of whiny “investors” who want the Fed to make them richer. I have been investing since the 1960s in much more difficult conditions than we have now. I earned less than average pay and my wife got about 60% of what a man would have earned in her job. Still, we managed pretty well and sacrificed less that we might have. Five percent interest is chicken feed. Instead of hollering at the Fed maybe these “investors” should go after the corporate bosses spending all the company money on buybacks. It seems to me that CTAs and derivative players have a much larger playground with more tools and more options than simple market punters. Rates up, rates down, vol up, vol down, etc. There are apps for those. Sitting around begging for exogenous drivers to turn favorable is kind of embarrassing and to my mind reflects a certain lack of skills. The Fed’s job is macro management not stock market enrichment.