The Fed: Hard Landing First, Soft Landing Second
More pre-Powell prep.
Victoria Guida is out this morning with a critical piece of evidence pointing to where FED policy and communication is headed in the coming weeks and months, starting today with Powell’s press conference.
Three days before the July 12 CPI report I wrote about my communication with someone close to the Fed and how it looked like the Fed was preparing to “go for” a soft landing, and that narrative only continued in the wake of CPI, punctuated by former FED official Rich Clarida floating the possibility the Fed could start cutting rates next March. But since then, the long end of the TIPS break-evens curve shot up and broad market sentiment has taken on a distinctly bullish tone, one that is exceedingly unhelpful for a FED trying to engineer a soft landing. You see, by “going for” a soft landing, the Fed actually undermines its ability to engineer a soft landing because financial conditions ease in anticipation of the soft landing. If the Fed is serious about bringing sticky above-2% inflation back to 2-3% on a structural basis, it FIRST must engineer a hard landing, and THEN attempt to engineer a soft landing by responding appropriately to the economic downturn in a way that keeps the unemployment rate from going “nonlinear”.
The long end of the TIPS break-evens curve is moving up.
And the soft landing narrative is spreading like wild fire (Bill is the preeminent soft landing bull on “FinTwit”, so his commentary is a good sentiment tell).
If you analyze the totality of FED communication since July 5 and July 10 of last year when it communicated through Nick Timiraos that it would not repeat the “stop and go” policy error of the Burns Fed, it is very clear that the Fed understands this “hard landing first, soft landing second” framework. They’re trying to engineer a “controlled demolition” so not to be forced off course (SVB is the quintessential example) and prematurely ease monetary policy - hence the obsessive soft landing talk. But by trying to maintain a “put” under (i.e. BTFP) and a “call” over (on-going rate hikes) financial markets, the Fed is working against itself by encouraging broader financial conditions to ease, which in turn forces them to raise rates more than they otherwise would need to, which ultimately imparts undue harm on the economy.
But they continue to raise rates knowing full well they’re imparting said “harm” on the economy. This tells me they understand the “hard landing first, soft landing second” framework. I just think they’re going about it in the wrong way by not forcing asset markets to do their work for them. But whatever - we as financial market participants need to play the ball where it lies.
Back to Victoria.
In her Politico write-up this morning Guida confirmed the Fed is very much back on the recession train, revealing that privately some at the Fed are signaling they will “probably have to push up unemployment to curb wage gains.”
This change in communication is a very big deal, just as broad market sentiment is rapidly shifting away from the recession narrative and toward the “FED doesn’t matter” narrative. And it’s important to keep in mind that this is not simply hawkish rhetoric designed to keep a lid on financial markets - the yield curve very much confirms the Fed is “going for” a hard landing.
Buckle up for a very interesting period here into the September/October danger zone.
3y/10y UST curve continues to re-invert, now just a touch below its tightening-program-to-date highs.