There’s good news and bad news if you’re Jerome Powell.

The good news is, the 2022-2023 rate-hiking campaign is on the verge of becoming the exception to the rule.

Generally speaking, Fed hiking cycles break something. And while there were some harrowing moments (most notably the October 2022 gilt crisis and the March 2023 US regional banking drama), nothing’s “snapped” just yet.

The familiar figure above, from BofA’s Michael Hartnett, is an annotated reminder of… well, a lot of things, actually. It’s a reminder about a lot of things. But for our purposes here, the point is that tighter US monetary policy leads to, contributes to and otherwise presages, busts. I’d be remiss not to mention that some of those busts represented an unwind of bubbles stoked by easier US monetary policy. (Ah, the cycle of life.)

Powell, who isn’t an economist, is on the verge of achieving the vanishingly unlikely: A hiking cycle without a subsequent crash or recession. That’s no solace on Main Street, where the generational inflation shock Powell failed to preempt continues to strain household budgets, undermining whatever’s left of the increasingly elusive “American dream.” But if you’re fortunate (rich) enough that recent price increases were little more than an inconvenience, you can celebrate Powell’s “victory” as a miracle.

So, that’s the good news. The bad news for Powell is that the domestic economic resilience — with particular emphasis on the US labor market — which is facilitating the soft landing makes it very difficult to judge the correct size and timing of rate cuts for the purposes of “insurance.” If the Fed gets that wrong, they risk rekindled animal spirits and, in turn, another battle with the inflation demon.

Consider the figure below, which shows the Chicago Fed’s gauge of national financial conditions.

As you can see, it’s the easiest since December 2021, and sits at levels which count as loose historically.

Put as a question: What’s going to happen here if the Fed continues to cut rates with the labor market adding ~200,000 jobs per month, the stock market at (or near) record highs and credit spreads (IG) inside 100bps?

I actually don’t know the answer. Nobody knows anything. But the question’s supposed to be rhetorical: Such a conjuncture would, all else equal, be conducive to animal spirits and thereby inflation.

“Who could have possibly seen this coming?” Nomura’s Charlie McElligott quipped on Friday, calling recent US data, including this week’s ISM services beat, “spontaneous green shoots.” “The set up for an economic ‘animal spirits’ trade from this impulse easing in financial conditions has been quite obvious,” he said, before enumerating and elaborating as follows:

• The Fed kicks off their easing cycle with a dovish 50bps to make a “statement of intent” to reprice the market’s perception of “hard landing,” left-tail, policy-error risk…
• And in addition, the Fed remains asymmetrically tilted towards deep cuts with no tolerance for further increases in the unemployment rate…
• And all while China is stimulating hard, at the same time that rest-of-world central banks are commencing the largest collective stack of rate cuts since April 2020…
• And don’t forget: The US is buying back bonds for liquidity and “market stability” alongside cash management at a magnitude which is neutralizing ~40% of QT…
• And finally, all of this “easing” in FCI is occurring as US equities make all-time highs and credit spreads are back near tights.

The result: Upturns in the data and concurrent inflections in previously down-trending economic surprise indexes.

So, to Mr. Powell I say congratulations. But also, be careful. Don’t snatch defeat from the jaws of victory.

The hawks may have to fly one more time if the Fed wants to stick this landing.