“A bigger increase in cyclically-sensitive shelter prices will make it harder for Fed officials to shake reservations about starting rate cuts with a 50bps reduction next week,” Wall Street Journal “Fed whisperer” Nick Timiraos said Wednesday, following the release of inflation data which likely closed the door to a half-point first cut at the September FOMC meeting.
The CPI report made the optics of a 50bps out-of-the-gate move challenging for Jerome Powell, that’s for sure. Indeed, I’m duty-bound to inform you that the odds of an upsized move next week were rendered vanishingly small by the warmer-than-expected MoM core CPI print.
That said — and this is the paradox — a Fed that moves gradually in the presence of a clearly softening labor market is a Fed that risks being priced into an even more aggressive easing cycle than if the Committee had moved preemptively.
Without mincing words, the soundbites you read on Bloomberg, CNBC and so on are, almost as a rule, leaden and perfunctory commensurate with the job descriptions of the people from whom they emanate. That’s not to disparage anybody, it’s just to say if it’s enlivened, second-order thinking you’re after, you’re not going to get it from somebody whose job it is to be bland, right down to the tie and socks. Wednesday’s post-CPI Fed takes weren’t great.
Here’s the thing: A Fed that eschews 50bps cuts when the market wants them — and when the front-end’s shrieking for them via the widest FF/2s inversion on record — is a Fed that’s inviting STIRs to price more cumulative cuts for the cycle. Because the further behind the curve policy is, the higher the perceived risk of a hard landing.
Some officials get that, others apparently don’t. The ones who don’t will come around to it one way or another, though, because if they don’t catch up — or at least make a show of trying — markets will back the Committee into a corner through the financial conditions channel, which is to say make them choose between cutting big or delivering a de facto hike versus expectations.
Someone who understands this well — and someone who the financial media should be quoting every, single day, like I do — is Nomura’s Charlie McElligott.
“The rates market’s statement to the Federal Reserve is crystal clear: By willingly making the decision to do less cutting now, you’re going to be forced to do more cutting later,” he wrote Wednesday, in the lead-up to the CPI release.
That’s not idle speculation. As Charlie noted, Fed funds futures tipped 180bps of cuts by December of next year as of mid-August. Headed into this morning’s CPI update (so, a month later) the same cumulative pricing showed 264bps.
That’s effectively the market pricing higher odds of a hard landing. And that’s why you want to stay ahead of the curve. To reiterate: If you fall too far behind, the market’s going to railroad you into it anyway. At some point, the tension between i) how many rate cuts you’re “supposed” to deliver based on market pricing, ii) how much easing you “plan” to deliver based on the dots and forward guidance and iii) the time frame over which any disparity between those two needs to resolve, will become untenable.
That kind of disconnect can, of course, reconcile in favor of fewer cuts (as it did earlier this year, when the market was forced to back off after pricing in half a dozen quarter-point moves for 2024) but only if the data suggests the economy’s firming. In all likelihood, the data will suggest the opposite of that going forward. So, the Fed will be forced to play catch up. And what does it mean when the Fed’s playing “catch up”? It means they’re behind the curve.
McElligott drove it home. “The perception is simply that the Fed’s slow-play easing guidance will act to self-fulfill a deeper slowdown eventually, which will then require deeper ‘behind the curve’ / ‘policy error’-type rate cuts,” he wrote.
Late last week, Austan Goolsbee said the same thing, albeit not in so many words. “If you’re going to have a soft landing, you can’t be behind the curve,” he mused.
With all of that in mind, I’d pose this question: Does anyone seriously believe the upside risks to inflation from a 50bps cut next week are material such that going that route is too dangerous relative to the risks of falling behind the labor market curve?
I can’t imagine anyone with an informed opinion answering that question in the affirmative, which raises another question: Then why not just do 50 now?
Hit the nail on the head.
H 2028
Lots of good points in here, but I think there could be 2 possible counterarguments:
First, their playbook in 2022 was to start small and ramp up if data did not improve the way they wanted. People forget that during a raging inflation inferno in March 2022, they did just 25 basis points to start. In this case, you have labor market deceleration but not deterioration and a still near 3% inflation rate with inflation still top of mind as a concern and no appreciable stock market impact (its still near ATH)
Second, what would 50 now do to catch up to the labor market curve? Is the idea that it’s insurance for the future and that 12 months from now, it will drive more hiring? In that scenario, someone has to explain how “streamlining business operations through AI” like Dell and other firms are doing is going to be slowed or reversed by rate cuts. Is the idea that rate cuts will make firms both willing to spend on the enormous amounts expected for AI investments while also hiring at a faster pace?
https://www.theregister.com/2024/09/11/dell_layoff_sec/
“Second, what would 50 now do to catch up to the labor market curve? ”
I agree in principle with what’s implicit there, but if we go down that road (which I’m more than willing to go down), then the whole thing’s pointless.
That is: What would 75bps do to impact the labor market right now? Nothing. What would 100bps do to impact the labor market right now? Again, nothing. In fact, the Fed could cut rates to 0% tomorrow and it wouldn’t prompt Johnny Local to hire anyone right now, this afternoon, that he wasn’t planning to hire this morning.
I mean, if I’m honest, this is all just bullsh-t, right? It’s just pontificating for the sake of it. It’s entertainment. We’re just entertaining each other here. The economy’s going to do what it’s going to do and we — me, you, Jay and everybody else — will cope as we can. But ultimately, there’s no “managing” — let alone micromanaging — a $25 trillion economy. The whole idea of that’s absurd on its face.
I think you can both micro manage an economy (via regulations, mostly) and manage an economy… 🙂
But there fiscal might be a lot more important and a lot more controlled than monetary…
Seems a larger rate cut would make more contemplated projects “pencil out”, at the speed of Excel, and while those projects and their hiring wouldn’t start right away, companies would be more inclined to retain labor in anticipation of starting. Example would be construction projects. The rate cut would also quickly lower borrowing costs, and often rising profits -> less urgency to cut heads. This might apply most to smaller companies with typically more short-dated and variable rate debt e.g. bank loans.
That’s the experience my daughter and her husband are having right now. They have both been unemployed for 18 months from group director level jobs in tech firms where they had salaries modestly into into six figures. One was a victim of an Oracle acquisition and one from poorly thought out acquisition from a private player who changed his mind and essentially laid off the entire company he’d just bought. There aren’t as many jobs at this level as people think. All can be postponed or filled by inside “interims” until something changes or someone better can be found. At these levels flexibility is prioritized ahead of skills and insiders (already being paid) win over outsiders. Rates aren’t an issue in this part of the market. (BTW, I do love your comments.)