Fed Watch: John Williams Confirms Soft Landing Attempt
The Fed has shown its hand. Now we wait for the bond market to show its hand.
Discussion
In an interview with Colby Smith of the Financial Times out today, FRB New York President John Williams confirmed the Fed’s attempt at a soft landing with the following statement:
If total PCE inflation falls to 2.5-3%, the Fed does not believe it needs the unemployment rate above 4.5% to ensure inflation remains at its 2% target on a structural basis. THAT is as clear of a soft landing attempt as I’ve seen from the Fed tightening cycle to-date.
This is the Fed saying that well above-target Core Services ex. Housing inflation is not really a concern as long as goods, housing, and energy prices bring total PCE inflation down to 2.5-3%.
If the Fed has not done enough to induce a rise in the unemployment rate to 4.5%, and they just hold at a 525 lower bound after hiking in July, by going for a soft landing they are at serious risk of a reacceleration of inflation probably as soon as late 2023. Core Services ex. Housing inflation is directly tied to wages, which are driven by labor market tightness; and because elevated wage inflation underpins underlying structural inflation, by not raising the unemployment rate enough to ensure Core Services ex. Housing is brought back to 2-3%, any upturn in goods, housing, or energy prices will bring total PCE right back up to 4-5%, and the Fed will be forced to go back in and tighten even further.
The bond market will likely be the near-term judge of this soft landing attempt. If it sniffs out a reacceleration of inflation, the 3y/10y UST curve will likely bear steepen to 100-105%; if the Fed sticks the landing, 10s probably hang out in the 370-400 range, keeping the 3y/10y curve around 105-115%; and if the Fed has already gone too far (defined as having done enough to push the unemployment rate up to 4.5% by YE23), then I would expect the curve to stay inverted in the 115-120% range until the Fed starts floating rate cuts.
The Fed has shown its hand. Now we wait for the bond market to show its hand.