By Michael Every of Rabobank
Where is Your Brain(ard)?
A simple Fed summary: rates were hiked 25bps to 4.75%, as expected; Fed Chair Powell floated *two* more such hikes, above what had been expected; and he made a stream of hawkish comments. However, he didn’t hammer home the point about loosening financial conditions much, and he noted disinflationary aspects to the economy.
The result? Another everything rally: lower bond yields, a weaker dollar, higher equities, mostly higher commodities, higher gold, and higher Bitcoin. As our Fed watcher Philip Marey put it, “Groundhog Day”.
The market is now pricing rate cuts this year and a slew to follow in 2024 despite the clear official message that the former at least is *not* going to happen. Philip generously notes Powell “sees the divergence between FOMC projections and the Fed Funds futures market rather as a difference in economic outlook than as disbelief in the Fed’s conditional prediction that given their outlook they are not going to cut rates this year.” It’s generous in that it overlooks that the market can’t forecast the economy either, and is disbelieving the Fed only because it means another bad year for assets, which it is fighting all the way to the bank.
It’s not that Powell didn’t suggest rates could come down. In fact, he said if CPI comes down faster than expected, which tweaking the base year of comparison to 2022 sure helps, it will play into policy. And, yes, BLS tweaky, tweaky, market-likey.
Crucially, however, Philip stresses “Powell does not see a sustainable decline to 2% inflation without balance in the labor market.” And what did we see yesterday in that regard? A solid, if weather-hit, ADP jobs print given how tight things already are; and US JOLTS job openings surging far more than the market had expected to over 11 million, such that there are now two job opening for every applicant. Tell me how this leads to much lower wage growth without a sudden U-turn towards a far more violent, far higher upwards shift in unemployment than the Fed is forecasting? And, let me add, the market too: they also expect a benign drift higher in unemployment as the median outcome – I told you they can’t forecast the economy and are just talking their own books.
Philip concludes, “we continue to think that the risk to our terminal rate forecast is predominantly to the upside. New exogenous supply shocks and the endogenous wage-price spiral could push the Fed even further than they now anticipate. Note that our concern about the wage-price spiral would particularly affect core services ex-housing inflation, the only place where disinflation is not visible yet according to Powell. Unfortunately, if wage growth is going to persist at elevated levels, that extra 25bps in May the FOMC is now thinking of may not be enough. If core services ex -housing inflation is going to remain high, it could require an extra shock to the labour market that will take the top of the target range to 5.5% or even 6.0%, instead of the 5.0% that we have in mind or the 5.25% that the FOMC has pencilled in.”
In short, if the market is acutely self-serving rather than accurately forecasting geopolitics and the economy, it risks getting a 6% Fed Funds rate ahead.
Where is your brain if you can’t see that, as well as the downside risks to the US economy if we get the kind of labor-market weakness that justifies what the bond market is now doing?
Philip also notes “press reports suggest that Fed Vice Chair Lael Brainard may be moving to the National Economic Council soon. This could weaken the dovish faction in the FOMC, which just gained strength this year in terms of voting rights. However, it cannot be ruled out that President Biden nominates another dove to replace her.”
Where is your Brain(ard) if you can’t see such Kremlinology is worth paying as much attention as actual Kremlinology and Politburology, and a very big dove may be on the way out?
The latter two ‘ologies’ also have more of an impact on the Fed than dovish market brains want to see, as Philip alludes to. Relatedly, Branko Milanovic today refers to recent musings by Adam Tooze on the troubling-loose definition of polycrisis (which in early 2022 I had called a metacrisis), geoeconomic fragmentation, friend-shoring, and ‘slowbalisation’, etc., vs. the view of this as all being ‘just history’: “More fundamentally, one could say that the problem @adam_tooze identifies is due to the lack of any conceptual framework within which to situate the current developments. If you have no framework, you just see a bunch of weird events… The guy who first comes with the framework which is not just the two hyphenated terms, or two words slapped together will win.”
As I argued in 2020, we need a new, ‘next normal’ ideological “-ism” for politicians –then central banks– to hang their hats on.
Where is the brain that will provide it? I don’t know – but it won’t come from markets.
Of course, it is pretty unlikely that it will come from central banks either.