Fed Watch: "Why Wouldn't They Go For It?"

The Fed is "going for" a soft landing (as confirmed by my email exchange with a quasi FED insider), but the bond market's "bear steepening" move may be calling the Fed's bluff.

Discussion

I have to admit that I am confused about the current state of FED policy. As I’ve been writing about on the Fed Watch channel, my read of policy was that the combination of seemingly hawkish FED and ECB communication and a rapidly inverting 3y/10y UST curve said the Fed was in the process of re-hawking in response to better than expected activity and inflation data. But now I’m questioning my read as a result of my conversation with the aforementioned quasi Fed insider (see the transcript below) and commentary from Nick Timiraos in today’s WSJ.

Since this tightening cycle began, when the 2s10s UST curve began to steepen as a result of rising nominal and real 10s (i.e. a bear steepening), it was typically accompanied by very hawkish FED communication. The exception was the steepening in December 2022 that was short-circuited by “soft landing” data prints on wages in early January that were quickly accompanied by a dovish shift in FED communication. This latest bear steepening has two unique characteristics, at least so far: 1) the Fed is actively “going for” a soft landing, and 2) 10y break-evens are just 227 bps versus the 250-300 bps at the start of the last three bear steepenings. These two characteristics lead me to believe this latest bear steepening is either a fakeout move that is likely to reverse on a softening in Core CPI data over the next two months, or the bond market calling the Fed’s bluff on its “soft landing” attempt.

How the bond market trades in response to Wednesday’s CPI report will be key in assessing the durability of the move in rates.

The Transcript

The WOTE:

The Insider:

The WOTE:

The Insider:

The WOTE:

“Going for It”

The Timiraos outlook column in today’s WSJ confirms the above email exchange: The Fed is in fact going for a soft landing.

While the Fed makes a limp-handed attempt at its commitment to holding rates “higher for longer”…

…The real “tell” is the fact that hiking in September following a hike in July is likely off the table if Core CPI comes in soft in June and July.

Why is that a “tell”? Because in the June SEP 12 out of 18 FOMC members penciled in at least two more hikes in 2023, and Powell recently opened the door to hiking at consecutive meetings. Clearly the Fed has a weaker than expected Core CPI print in hand and is ready to declare a “soft landing” descent is underway. Otherwise, it makes very little sense to so quickly back off the re-hawking path it’s been on.