Post FOMC Thoughts
The FOMC came and passed. It was a marvellous performance. Powell patiently answered all bullet questions as to current needs and future plans to cut rates at possibly the same rate as just set out. How long is this race? If it’s a prolonged process, why start off at a pace you are already signalling will not hold in the months ahead? It was a bit of farce at times, I have to say. Also, he seems to let out this weird cough before answering trickier questions. Has anyone else noted this?
Markets initially reacted with some confusion by chopping around. I expected a 50 bps after the leaked articles. At least Niki-leaks will keep his job for now. Bonds sold off, which I have also highlighted as clearly they are pre-empting a slowdown by cutting aggressively initially and hence positioning themselves ahead of the curve after being seen behind in July.
The reality is neutral rates are probably around 3%, and we are still 200 bps above it. The traditional central banking book would tell you that you should be neutral at the point when recession probabilities are 50/50 and inflation is firmly expected to be on target on a 12-month horizon. You could argue that neither of those conditions has been met. Instead, I think it really is a calibration to bring real rates lower or not allow them to increase as inflation has been tracking lower. This is a sensible approach.
Although one could argue the last of inflation remains sticky (the SEPs don’t have core PCE back to target until 2026 if you look at the SEP table below), the Fed, after all, isn’t the ECB, and it isn’t fixated on inflation alone. Instead, its focus is now firmly on the jobs market. This is a case of cutting quickly now to avoid deeper cuts another day.
No wonder this current setting is enticing some risk-taking to be explored again. Jay just told you he and his buddies got your back. The economy? They haven’t got more of a clue than you. I don’t think the economy is in such a bad shape, so this and the coming rate cuts could just be fuelling another euphoric risk ride. I would expect steeper curves and higher commodity and equity markets. What breaks it? Well, don’t forget that there is still an election on the horizon. It might not matter, but some will take notice as to what plans are likely to emerge and be adapted. This might be some months off, for sure. Until then, we will all be watching how the economy trickles along. My gut feeling is that they are possibly going to cut to 3.5-4% and then have to abort the cutting mission as they realise that the economy is not falling apart and the jobless rate hasn’t even climbed to 4.5%. In that scenario, equities will have to adjust as they will have to address the fact that the Fed will have to stop and possibly reverse the policy. Bonds, in that case, are rich. I am discussing bonds and curves more in the paid section below.
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Let’s also read my friend Macro D’s recent thoughts on markets before engaging our scanning eyes across the multitude of charts that I have updated for you below. But first, let’s dive in a bit more on where bonds and curves are likely headed next.
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