Happy FOMC week, everyone!
Futures markets are pricing in another 75-basis-point rate hike from the Federal Reserve this week. That would bring the fed funds rate into a range of 3.75 to 4 per cent, which is high! Compared to the last 15 years, at least!
The yield curve is looking extra recessiony and inverted, with the three-month bill yielding 4.2 per cent, above than the 10-year note’s 4.1 per cent. And Wall Streeters keep talking about an elaborate ritual called a “pivot”. (Rhymes with “Godot”, correct? Must be French.)
The first step in this dance is apparently called a “downshift”, which we imagine is similar to a curtsy. The sellside expects this will occur early next year, or possibly even in December, depending on how the data play out. We saw the first inkling of a central bank curtsy in Canada last week, but the Fed is what matters.
Deutsche Bank appears to be leaning toward next year for a prediction, while Goldman Sachs and Bank of America expect Fed Chair Jay Powell to hint that the pace of rate increases could slow next month. After this there will apparently be more waiting to see how the Fed’s dance partner (the economy) will respond.
This pivot choreography doesn’t sound like it’ll be especially fast-paced. Instead it seems like a sombre, formal and measured departure from the herky-jerky pace of Covid-era monetary and fiscal policy. Goldman Sachs’s Jan Hatzius and his team highlight that they expect the Fed to move slower with its rate increases after November:
We do not expect Powell to tie a slowdown to 50bp to meaningfully better inflation data, which is not a realistic expectation at such a short horizon. Rather, Powell will likely note that the FOMC aims to move deliberately but more cautiously now that the funds rate is in restrictive territory, and that the full impact on the economy of the very large tightening in financial conditions to date is not yet clear. We expect the FOMC to eventually pair that slowdown to 50bp in December with a somewhat higher projected peak funds rate in the December dot plot. We are adding another 25bp hike to our own forecast — which now calls for hikes of 75bp in November, 50bp in December, 25bp in February, and 25bp in March — and now see the funds rate peaking at 4.75-5%, as shown in Exhibit 1.
Strategists at Bank of America also expect the Fed’s pace of tightening to slow in coming months. But they say it’s the final interest rate destination that matters most:
Committee members may also be reluctant to signal a slower pace of hikes lest financial markets interpret the decision as a “dovish pivot”. In recent FOMC meetings, the Fed has been clear in its “higher for longer” communication and focus on reigning (sic) in inflation. In our view, one way to lean against this interpretation would be to emphasize that, despite any forthcoming step back in the pace of rate hikes, the committee’s view on the cumulative amount of tightening needed to remove labor market imbalances has not changed.
In other words, appropriate policy is now ultimately about the final destination and not the journey. By reaffirming the September median policy rate path, repeating consensus FOMC views that risks to the outlook for inflation still reside to the upside, and emphasizing a willingness to err on the side of tightening too much over tightening too little, we think the Fed can be successful in pushing back against any interpretation that a slower pace of rate hikes implies a lower terminal rate or a quicker pivot to rate cuts. In other words, it is now about the destination, not the journey. We expect the Chair to emphasize these points in the press conference.
So is it the destination or the journey that matters? Wall Street doesn’t agree. But maybe the real recession was the friends we made along the way 🙂
Source: Economy - ft.com
