💵 Freaking The Fed Out

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People are freaking out about the Fed again. Will today's decision (and comments) actually change anything?

I don't think it will. Thanks for reading. Chat again soon.

No really. What can the Fed actually do to shock the market? We're getting a 25bps hike today (99.3% priced in according to FedWatch), and very likely (82%) to get another one in March.

May is a lot less certain, although quite a few of these guys think we see another 25 then too... 👇

MNI / Doejistar

But that's all pretty much 'priced in' to rates markets and has been for some time.

In a 19th of January speech (titled staying the course to bring inflation down) Vice Chair Brainard said:

Turning to the implications for policy, my colleagues and I are committed to restoring price stability. The FOMC moved policy into restrictive territory at a rapid pace and subsequently downshifted the pace of increases in the target range at its most recent meeting.

This will enable us to assess more data as we move the policy rate closer to a sufficiently restrictive level, taking into account the risks around our dual-mandate goals. In parallel, balance sheet runoff is continuing.

Even with the recent moderation, inflation remains high, and policy will need to be sufficiently restrictive for some time to make sure inflation returns to 2 percent on a sustained basis.

Translated into normie speak, Brainard thinks rates are already restrictive and starting to weigh on the economy. However, she's not sure that they're sufficiently restrictive just yet so a slower pace of hikes is justified.

The mention of the dual mandate is a nod to the risks of doing too much and excessively harming the labour market.

Then there's the final line... "for some time" which is the bone of all contention. How long....?

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Frankly, nothing much they say today should change many minds. Unless the Fed can somehow convince markets that the rate cuts priced for later in the year are off the table... 👇

Steve Hou / BBG

But what can they really say to make markets believe? They're slaves to the data, same as the rest of us.

They can't really come out and say definitively that there won't be cuts this year.

Their ability to see the future is as questionable as it ever has been. There'll probably be a nod to the uncertainty (Brainard also mentioned this in the recent speech) 👇

Nonetheless, substantial uncertainty remains. Further shocks associated with the war and the pandemic are possible. While there has been some improvement in the outlook for activity and inflation in Europe, there is uncertainty about the implications of China’s exit from zero COVID for global demand and inflation, especially in commodities.

But that's it. What else is there?

On one side, you can definitely argue that inflation is coming down, and wages are coming off the boil too (further evidenced by yesterday's Employment Cost Index).

It's all good progress of getting things back towards 'normal' 👇

But it's along way from declaring 'job done'.

The rise in layoffs is also high on the list of things the Fed wants to see. A weaker labour market is one of the key components for a better economic balance.

But it's STILL mainly concentrated in tech, where over-hiring was rampant during the pandemic 👇

 WM. BLAIR: “.. data suggests that the recent plethora of [tech] layoff announcements could be more appropriately viewed as an indication of labor market rationalization, where headcount is effectively shifting between companies .. rather than being removed from the market ..” pic.twitter.com/tT8uaOqv1b— Carl Quintanilla (@carlquintanilla) February 1, 2023 

And we're a LONG way from anything like a return to the easy money era.

Even if they're cutting rates later in the year, various Fed officials think there's plenty of runway to keep QT running in the background regardless 👇

 Gov Waller did a good interview with CNBC with comments suggesting that QT will continue for some time:

1) QT slows when RRP + reserves around 10% GDP (~3 years at current pace)

2) open to QT while cutting rates (35:38).

h/t @dampedspring @aRishisays https://t.co/TDYE7JtCmU— Joseph Wang (@FedGuy12) January 20, 2023 

New York Fed President John Williams said this month that the roughly $2 trillion parked daily by money market funds and others in the Fed's overnight reverse repo facility is the "key" to the outlook. As markets adjust to rising interest rates, cash will start to flow from this facility into the private sector and effectively replenish reserves levels, giving the Fed the additional runway needed to keep cutting its holdings, he said.

Williams and Logan also believe the Fed can keep unloading bonds even when officials cut interest rates at some future date. In this scenario, the central bank could cut rates because inflation is abating sufficiently and a recalibration of monetary policy is warranted. As this would not be an easing aimed at providing stimulus to a flagging economy but a more neutral action, the Fed could continue balance sheet reductions.

"That's not a shift in monetary policy, it's just an adjustment in the stance of policy due to the changing conditions," Williams said. "So I would expect, you know, the process of balance sheet reduction to continue as it is."

None of which makes much sense in the real world (if the economy needs the support of lower rates, QT is negating some of that impact). Regardless, it gives an idea of where the Fed's current thinking is.

Whatever happens at today's meeting, the data still matters most at this point. Lower inflation and a weaker labour market is still 'required' before the Fed will even consider saying that p word everyone wants to hear.

They might try to push back against the recent easing in financial conditions 👇

The press conference will be the main point of interest, but there's very little they can credibly say/do that will convince the market of anything.

It's all about jobs and inflation. Starting with the ADP figure (expected at 178k) and JOLTS job openings (expected at 10.25M), both of which will be released today ahead of the meeting.

Then we've got the NFP on Friday, and the next CPI release on Valentine's Day. Romance isn't dead after all.