The Fed: Pre-Powell Ponderings
Discussion
With Core CPI surprising to the downside and the soft landing narrative running full blast among economic and financial market participants, the natural inclination is that the Soft Landing King, FED Chair Jerome Powell, will bless the widening path to a soft landing and it’s up, up and away for economic growth and equity markets with the Fed on hold and inflation vanquished. Two prior FOMC meetings against a similar narrative backdrop since the Fed’s tightening program began in late 2021 provide a template for how Powell is likely to handle his press conference on Wednesday: July 27, 2022 and February 1, 2023.
The July 27, 2022 press conference is now infamous: Powell talked ad nauseam about the signs of improvement in labor, inflation, and economic conditions, and the 2-year UST note yield responded in force, dropping more than 30 bps from a peak of over 320 in blackout the week prior, to under 290 in the immediate wake of Powell’s press conference. The Fed attempted to arrest this communication blunder soon after, sending FRB Minnesota President Kashkari out post-July 29 US equity market close to tell The New York Times the market had the Fed’s reaction function wrong. The Fed fought the market’s dovish interpreting of Powell’s press conference all the way up until Powell’s 8-minute Jackson Hole sledgehammer.
The key tell ahead of Powell’s dovish July 27 presser was the way 2s traded into the event. They were decidedly weak, and continued to trade weak following his remarks. Very clearly 2s sniffed out Powell’s dovishness in advance.
Fast forward to February 1, 2023. After hammering home the need to keep financial conditions tight via the December FOMC SEP (surprisingly hawkish given continued progress on inflation), press conference (“It’s important that financial conditions reflect the tightening that’s been put in place”), and post-meeting communication (reiteration from all FOMC members of the need to raise to 500, and a critical op-ed from Dudley telling the market to stop fighting the Fed), wage data started to come in below expectations in January reporting, and the soft landing narrative took off. Prior to the January 31 FOMC Larry Summers now-famously said “soft landings are the triumph of hope over reality, but sometimes hope wins out,” and Powell delivered on February 1. At the February 1 press conference Powell said that the “disinflation process was underway” so many times that it became its own meme. Rates dropped and stocks ripped in response.
Like July 27, 2022 the key dovish tell ahead of Powell was how 2s traded. From a peak of over 440 in December to circa 415 ahead of Powell’s February 1 press conference, 2s were clearly anticipating dovish messaging, and they continued to fall in response, bottoming out around 410.
Heading into next week’s FOMC meeting, 2s are very much trading in line with the pre-dovish Powell pattern ahead of the July 27, 2022 and February 1, 2023 FOMC meetings: an initial spike down (this time from over 500 to under 470) followed by an upside retracement into FOMC week. If this pattern is to continue, 2s will start to fall into Powell on Wednesday.
I am wide open to Powell unleashing the soft landing bazooka, and if 2s start to soften on Monday I’m all in on that view. But my gut says this time is different. 2s are responding to softer macro data in a way that tells me they want to go higher. So we’ll see what happens. Open mind is key.
Confirmation of Powell’s message and tone will likely come from Nick Timiraos’s pre-FOMC preview tomorrow or Monday morning.