Moderating the pace of interest rate rises in December?

Last Wednesday, two weeks before the next FOMC meeting on 15 December, Fed Chair Powell spoke at the Brookings Institution.

While it was not an official FOMC meeting, markets treated it as such because Fed guidance, however unofficial, is the vanguard of the Fed’s policy transmission mechanism.

And while he did lay out a balanced/nuanced view on life, love and inflation, he let the dove out by indicating that the December FOMC decision is likely to include a lower magnitude interest rate hike. In saying that, he also warned about more rate hikes for longer.

WT?

And you guessed it, the price action in markets after his appearance again showed that risk markets consistently choose to hear the dove and fade the hawk.

Here’s what risk markets chose to hear:

“After our November meeting, we noted that we anticipated that ongoing rate increases will be appropriate in order to attain a policy stance that is sufficiently restrictive to move inflation down to 2 percent over time. Monetary policy affects the economy and inflation with uncertain lags, and the full effects of our rapid tightening so far are yet to be felt. Thus, it makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down. The time for moderating the pace of rate increases may come as soon as the December meeting.”

And here’s what risk markets chose to fade:

“Given our progress in tightening policy, the timing of that moderation is far less significant than the questions of how much further we will need to raise rates to control inflation, and the length of time it will be necessary to hold policy at a restrictive level. It is likely that restoring price stability will require holding policy at a restrictive level for some time. History cautions strongly against prematurely loosening policy. We will stay the course until the job is done.”

“It seems to me likely that the ultimate level of rates will need to be somewhat higher than thought at the time of the September meeting and Summary of Economic Projection.”

“……..but for now, I will simply say that we have more ground to cover.”

Below is the SEP, with my white sharpie mark-ups which contrast the Fed’s earlier view in June.

I have not bothered to deface the dot plot again, but based on Powell’s comments, it looks like we’re going above 5% next year campers, and that restrictive rates will be held in place for some time.

But whether rate step-ups are higher frequency/lower quantum (i.e., a few 50bips hikes as opposed to one or two 75bips) remains to be seen.

The Fed retains full optionality.

After his speech on Wednesday, 2-year treasuries mooned to 4.27%, severely inverting over the 10-year which fell to 3.5%. The bond market is calibrating higher cost of capital further in, but clearer skies further out. More players are buying bonds in the belly and at the end of the curve.

But equities just partied, particularly the growthy end, and gold found its mojo because a pause, pivot and eventual stimulus (i.e., dollar debasement) came into closer view.

And the same routine continues. Risk markets hear the dove and fade the hawk, even though there was only one solitary shred of dovishness in the entire speech.

Essentially, risk markets interpreted Brookings as a leading indicator for the Powell Pivot and given dollar debasement commodities like gold and bitcoin are up today, no new view has surfaced over the weekend.

Powell’s been pretty consistent

I’m paraphrasing, but here are the other key points from his address:

• The reality is that inflation remains far too high.

• So, when will inflation come down? The path ahead for inflation remains highly uncertain.

• Still uncertainty about what level of interest rates will be sufficient restrictive to bring target inflation down to 2% target.

• Interest rates will end up higher than forecast at the September meeting.

• Not trying to destroy the economy. Rather, tightening policy rates in order to slow growth in aggregate demand – with sufficient demand reduction to restore balance and return to stable prices, but this will require a sustained period of below trend growth.

• Expecting to end up with very low growth this year, and we have revised down growth for next year but there’s still no clear progress on slowing inflation.

• Restoration of balances in relation to supply and demand in the labour force (currently demand>supply) is not yet apparent and this will be a major determinant of inflation.

• Unemployment rate is 3.7% and job openings > available workers by around 4 million and so far, there has only been minor moderation in demand.

• There is a long way to go to restore price stability.

• The expected natural reversion of supply shocks back to a normal has still not occurred.

• By any standard, inflation remains far too high.

If left to his own devices and while populist Joe Biden remains his boss and believes “QE is reverse taxation for Wall Street whereas inflation is taxation for Main Street,” Powell is nowhere near finished normalising the cost of capital nor the amount of lazy reserves in the banking system.

The fact that a lot of the excess is expressed as multi-trillion dollar balances in reverse repo accounts and/or parked up at the Fed (paying interest) is a separate issue which I wrote about last week.

Conclusion? More rate hikes to come, for longer, and based on his comments about exceeding the SEP levels, we’re probably going over 5% next year.

This is way more hawkish than dovish, right? And yet the market continues to front run a Powell Pivot and continues to fade his hawk. Just look at the price of Gold for evidence of that. Gold does well when the market expects dollar debasement.

But perhaps on Friday a dove spoiler?

As we know, Powell keeps a close eye on the Core PCE Index. It’s his favourite measure of inflation. More than half of that index is made up of core services other than housing. And wages make up the largest cost in delivering those services.

Thats why a high job print/all-time low unemployment are reasons why Powell says we have a long way to go, i.e., he regards jobs growth as a key indicator of demand, which he wants to reduce and is waiting to see evidence of that in the numbers.

Given that, I imagine he and his Fed colleagues must have been particularly confounded (or at least frustrated) when two days after Brookings the non-farm payroll print came out well above expectations, with 263,000 jobs added in November and unemployment remaining at multi-decade lows of 3.7%.

Oops. That’s 2.6x higher than what Powell thinks is the level required to accommodate population growth, i.e., ~100,000 per month. That doesn’t sound like impetus for a pivot, nor moderating job growth to me, nor even a modicum of a scintilla of a moderation in demand. Unless it’s because a lot of people are taking on two to three jobs to make ends meet.

Still, they are the numbers the Fed and markets have to work with, so I wonder whether he would have made his December Dove comment had he appeared at Brookings after the payroll print.

Hard to say.

Plus, who’s to say even if it is 50bips on the 15th, that there aren’t more of them, i.e., 2 * 75 = 3 * 50 = 6 * 25...

Stay tuned campers. And remember, even if the market has it wrong, the market is always right - because it is the market.

Mike