Good morning. Fed day turned out to be quite dull, going mostly as expected. But we still think many observers are mischaracterising Federal Reserve policy and misunderstand what the Open Market Committee is saying. It’s not that the Fed is being subtle; it’s that some people are ignoring the literal meaning of its statements, which show that the “Powell pivot” is a tactical tweak by Fed that remains very dovish indeed.
Email us: robert.armstrong@ft.com and ethan.wu@ft.com.
‘Transitory’ in all but name
The most surprising thing in the Fed’s sedate December meeting was the news — delivered in the notorious “dot plot” — that monetary policy committee members project three interest rate increases next year, rather than the two consensus called for.
Even this spooked no one. The stock market was pleased, in fact, rising by a merry per cent or two. The policy-sensitive yield on the two-year Treasury note did not move at all. Five and 10-year yields rose an indifferent couple of basis points. The US central bank’s communications strategy seems to be working perfectly.
Some observers see the committee’s higher rate expectations, as well as the as-expected faster taper of asset purchases, as signs the Fed has been forced into a dramatic shift in approach. Here’s BlackRock’s Rick Rieder:
“We would suggest, however, as we have for many months now, that this is what it looks like when the Fed is running behind the curve and needs to catch up to rapidly changing events on the ground.”
One sellside strategist thought the accelerated tapering showed the Fed capitulating on its “transitory” narrative:
“Inflation has clearly passed the point where it could be considered transitory, and the Fed acknowledged that by accelerating the pace of tapering of asset purchases.”
Another strategist echoed the idea:
“The notion that elevated inflation levels would be transitory has finally been thrown out the window by the Fed.”
It is true that the dot plot, charting central bankers’ expectations for future rate rises, unambiguously shows the Fed eyeing higher rates sooner. Here is the plot from back in September:
And here is the new plot:
But this is tactics, not strategy. As telegraphed, the Fed is acknowledging short rates will need to rise somewhat to hedge against persistent inflation. That is evident in the 2022 and 2023 dots. But the median forecast for rates in 2024 nudged up only a bit, from 1.75 per cent to just over 2 per cent. The longer run dots have stayed the same.
In the background is the very clear fact that the committee thinks, with a high level of unanimity, that a short raising cycle, topping out at 2.5 per cent, will ensure that inflation is transitory. The committee’s median projection is that personal consumption expenditure inflation in 2022 will be 2.6 per cent, and it is unanimous in thinking that in 2023 it will be barely above 2 per cent.
That is, above target inflation will last about a year. Everybody, say it together now: transitory! The Fed retired the word, but it still thinks the same way.
As we have argued before, the bond market wholeheartedly agrees with the Fed’s attitude. Five-year inflation break-evens, after trending down this month, float near 2.7 per cent. And the rate futures market is actually more dovish than the Fed: it thinks the rate raising cycle will top out below 2 per cent.
The flat yield curve does not, as some people have argued, predict a too-late, over-tightening Fed mistake. It predicts that the US central bank can stop inflation with a feather.
As our friend and rival John Authers at Bloomberg pointed out on Wednesday, both consumers and a majority of money managers agree with the bond market that inflation will not last long. The only market signal that might be expressing the contrary view is long-shot technology stocks, which have been selling off hard (though they rose on Wednesday).
One explanation for this is that they are very rate-sensitive and are anticipating rising long-term rates. Another explanation, though, is that they were trading at stupid prices, and stupidity has been subsiding.
Even if the Fed does get to a 2-plus per cent policy rate, that will constitute a very mild tightening of policy, Morgan Stanley’s Jim Caron points out:
“Fed signals a policy move to neutral by 2024 not tightening . . . 2024 fed funds rate median of 2.125 per cent vs core PCE inflation at 2.125 per cent. Thus [a] real policy rate of 0 per cent by 2024.”
That Fed chair Jay Powell’s attitude has not changed with his rhetoric was made clear in his press conference after the FOMC meeting on Wednesday, where he expressed serious concerns about the labour market and the participation rate in particular. This is not a man who sees the US economy settling at a strong level after the pandemic.
The Fed’s projection for real gross domestic product in 2024 and beyond is an uninspiring 2 per cent. Even that may be above trend, given weak productivity growth and demographic headwinds.
After inflation subsides, the new “new normal” will probably look a lot like the old “new normal,” which worried everyone in the years leading up to the pandemic.
The Fed, the bond market, consumers and money managers may all be wrong that inflation is unlikely to persist (we at Unhedged are not smart enough to predict inflation). But don’t be confused by a change in terminology by the Fed.
Everyone, from Powell on down, is betting on transitory. If the bet is lost, it’s going to be ugly. (Wu and Armstrong)
One good read
This post from Bank of England staffer Thomas Belsham raises one of the hard questions facing bitcoin: what happens when the maximum number of coins have been mined, meaning that bitcoin miners — who do the work required to keep the common ledger secure and up to date — can no longer get paid in new coins. The question is not new, but it is very clearly explained here.
Source: Economy - ft.com
