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Discussion
In his customary Tuesday morning FOMC preview part 2, Nick Timiraos confirms a very hawkish Chair Powell will step to the podium tomorrow at 2:30pm EST. Three key points:
The piece bats away Wall Street expectations for 1-2 cuts to start later this year.
While most Wall Street strategists think one or two rate cuts are still possible later this year, the prospect of such a recalibration without clear evidence of economic weakness remains a bigger wild card than it did just a few weeks ago. Some think the Fed might not cut at all.
Multiple times Timiraos shoots down the prospect of a hawkish pivot toward rate hikes. In other words, tell me you’re prepping for rate hikes without telling me (lol!!). This is the Fed’s slow-moving way of softening the beach for hikes later this year.
…Powell might be hard-pressed to rule out any additional increases, even though it is likely premature for officials to meaningfully move in that direction.
But a hawkish pivot, suggesting an increase in rates is more likely than a cut, appears unlikely, for now. Any such shift is likely to unfold over a longer period. It would require some combination of a new, nasty supply shock such as a significant increase in commodity prices; signs that wage growth was reaccelerating; and evidence the public was anticipating higher inflation to continue well into the future.
Most importantly, the Fed views the long end of the UST curve as doing the tightening job on their behalf. In short, the Fed wants lower asset prices.
As financial-market participants anticipate fewer cuts, longer-dated bond yields will rise. In effect, this achieves the same kind of tightening in financial conditions that Fed officials sought when they raised interest rates last year. Higher yields across the Treasury yield curve should ultimately hit asset values, including stocks, and slow the economy’s momentum.
Press Conference Preview
As discussed this weekend (see here and here), these term premium-driven asset price corrections have lasted exactly three months, and we’re one month into this latest iteration. With Election Day fast approaching, Jay & Janet likely view themselves as having a short window for slowing the economy and cutting the tail off 2024 inflation in time to ramp asset prices and growth into Election Day.
And no, Powell is not going to come out guns blazing in a Hawk Man suit. He’ll be smooth. He’ll be soothing. He’ll talk about supply-driven growth. He’ll gently say the Fed can “hold rates here for as long as necessary.” He’ll reiterate the Fed will bring inflation down “over time”. The Fed will announce a tapering of QT. All the dovish things bulls are looking for.
But buried inside the dove’s nest will be a handful of hawkish “eggs”. He’ll hint at no cuts this year. He won’t rule out hikes. He’ll put the possible need for “below trend growth” back on the table. He’ll say a 4-4.5% unemployment rate is still full employment.
Jerome Powell is no fool. He knows inflation is NOT coming back to 2% in an economy running with a 5-10% fiscal deficit in place. He knows full well a recession is ultimately needed to bring inflation back to 2% on a sustained basis.
He’s trying to thread the needle of election year politics while keeping inflation contained enough so he can go back in for the final kill in 2025. His December pivot killed the disinflationary process, and now he needs to engineer tight enough financial conditions to rein it back in. He’s got a short window to act, and act he will.
Thanks, very useful and valuable prediction.