Chair Powell Stands Tall

Another Fed meeting in the books. Largely as expected for those that follow us. We have been writing: "slower doesn't mean lower". Indeed this is what Jay Powell said yesterday. Terminal rate higher, US dollar higher, 2-year yields higher we go. Chair Powell had little ammo to deliver anything but what we received. And it's back to the data and economy with jobs tomorrow and CPI next week.?

2-year UST generally peaks above the terminal rate

We strive (demand from ourselves) to get these meetings right. And in March, the focus was solely on 25 versus 50-basis points. We were always in the 25-basis point camp to start but we received a great deal of pushback. Over the past week we've written extensively on markets being vulnerable and how Chair Powell would likely signal to the December Summery of Economic Projections for a higher terminal rate. After some 400-basis points of tightening it's no longer about the need for speed. It's about the "end to bend" inflation back toward 2%.?

Let's Take a Look:?

Vice Chair Brainard in a speech from October 10th. We covered it closely: "The combined effect of concurrent global tightening is larger than the sum of its parts".?Cumulative effects, lags, it's all been on the table. Taking into account lag effects is simply an eloquent way of the Fed saying the pace of rate hikes will slow following the past ten months. And the initial market reaction to the Fed's statement was costly.?

In the end, it's always been about the destination and ultimate cost of funding. Of course, the size and magnitude of each meeting matters in terms of the speed in which you get there. But Chair Powell was clear, and echoed what we already had learned and heard along the way; the cost of doing too little outweighs that of doing more. In essence, take them up and don't fret about going too far, because the easy remedy of we do is to bring them down. Bullard, 1994. We heard it in the FOMC minutes and now from the Fed chair himself. A Few Good Men: "Are we clear?, Crystal".?

2-year Yields: 1994-1995

For us, we've been writing and speaking about more not less. A 2-year yield that projects higher and will likely peak above the terminal rate if history serves us correctly. And a Fed chair that had no option yesterday other than to stand tall at that podium and say it straight. And that is what Jay Powell did. The downshifting is in motion. It could happen in December or in early 2023. The terminal rate will be higher in December in our projections (based on recent data). And the Fed's goal is to keep it there.?

This year is in the history books. And you would have to search long and far to find a pocket of time that central banks were tightening to inflict pain on the economy, consumers, jobs, and in many ways societal well being. Inflation is job number one. JP: How fast, how high, how long. And to be clear, the Fed doesn't know how high. They don't know how long either because "how long" will be predicated on "how high". And the how fast in now largely in the books.?

Our summary from yesterday:?

1) We have a ways to go and not close to a pause. Back to the data.?

2) Our phrase, "slower doesn't mean lower". Powell pointed to the December, SEP and we've written. We will see a higher terminal rate.?

3) It's time for the Fed to step down. But it's by no means a lock. But clearly the Fed is inclined to slow the pace.?

4) The risk is clearly tilted toward doing too little. Chair Powell was very clear, and we've referenced 1994; the Fed can always recalibrate lower if needed. But if we let the inflation genie continue to unleash, we have bigger problems.?

5) Terminal is more important than the increments now. We've written, make sense to us. Bottom line, Chair Powell and the Fed are far from confident where the endgame lies. That's been clear. Logically, with each outsize move you hope you're getting closer.?

6) Yield curve: thanks for the question and moved on very quickly.?

7) Beveridge Curve: a great one being bounced back and forth between Summers and Waller. Vacancies versus Unemployment. Chair Powell indicating relative to the JOLTS, that job losses could be less. He may be right. Labor force participation has NOT cooperated with the Fed. Nor have job vacancies.?

8) Rent inflation lingers and operates with a lag. History supports this: 12-18 months. And takes us into mid-2023. Fed Governor Waller recently wrote on this extensively.?

9) The Fed does not want financial conditions to ease right now. Bottom line, they will manage economic decline in 2023 with reducing rate increases, not easing.?

10) We have been calling for a 2-year yield to hit at least 5% in this cycle. And we remain committed to that view.?

On the ground

Chair Jay Powell got the job done. He's formally prepared the markets for a downshift while keeping options on the table in terms of exact timing. In the end, the Fed is still searching for that end game. But they realize after ten months, 400-basis points, and bumpy roads globally, a more cautious approach will likely be needed. There is nothing illogical with markets pricing a Fed Funds rate above 5% with core inflation but multiple measures running this high. Although Jay Powell did push back on the need to get the FF rate above the rate of inflation as the sole metric.

What does it mean in plain English? The Fed will continue to tighten until markets or the economy (jobs) tells them not to. If terminal needs to be at 6% and nothing breaks the Fed will go there. The one thing that was not clear yesterday was conviction in what that rate needs to be. Scary, right? But it's true. And we've written quite explicitly throughout 2022 that this is policy, more or less, trial and error.?

We still have a ways to go. With the risk being too little versus too much, curves move further inverted and the terminal rate priced higher. Logical. We sensed Powell would be questioned on yield curve shape. And he was. But he ducked the question very swiftly.

Breakage.?US dollar strength remains a global risk point and one in which we've vocalized from the outset of 2022. It remains so, and perhaps even more following yesterday's meeting. But we remain steadfast in our view that, at least for now, this remains every nation for themselves. The Fed isn't bailing out the UK pension system. Are there other landmines out there? Without question. Is the Department of Treasury and Federal Reserve prepared to protect the US Treasury market? 100 percent.?

USD strength continues following the Fed meeting and remains a global risk factor

Have a great day!