Monday Morning Notes, 12/11/23
If You Don’t Have Time This Morning
In the beginning of November we took an aggressive position is establishing a baseline scenario that the Fed would begin cutting rates in March 2024 for a total of 100bp in 2024. The logic of that scenario followed directly from Fed signaling, including from Chair Powell, that low inflation alone was enough to cut rates because the Fed needed to adjust policy to prevent the real policy rate from rising and overtightening monetary conditions. With inflation falling faster than expected, the Fed would pull forward the timing of rate cuts to ensure a soft-landing for the economy, in practice turning its attention to the employment mandate to prevent an unnecessary rise in unemployment. Given policy lags, if Powell was going to make a play for the soft-landing, which we believe he will attempt, the Fed would need to cut rates ahead of any significant slowing in the labor market. The longer rates stay high, the higher the chance of a hard landing, and the Fed would then need to cut rates more aggressively. A soft path for the labor markets or growth is not necessary for a rate cut but increases the probability that the Fed cuts rates in March and for a total of more than 100bp cuts in 2024.
This remains our baseline scenario.
FOMC Press Conference 12/13/2023
>> STEVE LIESMAN: Steve Liesman, CNBC. Happy holidays, Chairman. Fed governor Chris Waller said if inflation continues to fall, then the Fed in the next several months could be cutting interest rates. I wonder if you could comment on whether you agree with Fed Governor Waller on that, that the Fed would become more restrictive if it didn't cut rates if inflation fell? Thank you, sir. >> JEROME POWELL: Of course, I don't comment on any other officials, even those who work at the Fed. But I'll try to answer your question more broadly. So, the way we're looking at it is really this. When we started out, right, we said, the first question is how fast to move -- and we moved very fast. The second question is, you know, really how high to raise the policy rate. And that's really the question that we're still on here. We're very focused on that, as I mentioned. People generally think that we're at or near that and think it's not likely that we will hike, although they don't take that possibility off the table. When you get to that question, and that's your answer, there's a natural -- naturally, it begins to be the next question, which is when it will become appropriate to begin dialing back the amount of policy restraint that's in place. So, that's really the next question. And that's what people are thinking about and talking about. And I would just say this. We are seeing strong growth that appears to be moderating. We're seeing a labor market that is coming back into balance by so many measures. And we're seeing inflation making real progress. These are the things we've been wanting to see. We can't know -- we still have a ways to go. No one is declaring victory. That would be premature. And we can't be guaranteed of this progress. So, we're moving carefully in making that assessment of whether we need to do more or not. And that's really the question that we're on. But of course, the other question, the question of when will it become appropriate to begin dialing back the amount of policy restraint in place, that begins to come into view and is clearly a topic of discussion out in the world and also a discussion for us at our meeting today.
Monday Morning Notes, 12/11/23
We believe the dots will show the median FOMC participant expects the Fed will cut rates 75bp in 2024. In anticipation of client questions, we attached probabilities to three different scenarios for the 2024 dots:
The Treasury market rallied and swaps traders dialed up bets on interest-rate cuts after the Federal Reserve opted to hold rates steady at the conclusion of its policy meeting Wednesday but surprised markets with a more aggressive forecast for monetary easing in 2024.
Yields tumbled, with the policy-sensitive two-year note’s plunging as much as 23 basis points to just under 4.50%. The yield on the 10-year note fell more than 14 basis points to a low of 4.06%. Fed swaps show about 133 basis points of reductions next year, up from 113 basis points prior to the central bank’s decision.
“The Fed is definitely more in easing mode than people were projecting. This is definitely not hawkish,” said Andrew Brenner, head of international fixed income at Natalliance Securities LLC. “They upped the number of rate cuts in 2024 to three — a lot of people were thinking two,” said Brenner, adding that Fed Chair Jay Powell might look to portray the Fed’s decision-making as more hawkish during his upcoming press conference.
Monday Morning Notes, 12/11/23
At the press conference, Powell will continue to move the ball forward toward declaring the risk to the outlook as balanced but fall short of the mark. Given the normalization in the labor market, the increased confidence that third quarter growth was a fluke, and the general trend of inflation, the risks are clearly more balanced. The dovish risk here, and in the statement, is that Powell acknowledges that rates have been sufficiently restrictive since July and given that the SEP will show the Fed expects the next move will be a rate cut, that the risks are now balanced.
>> MIKE McKEE: Bloomberg Television Radio. Mr. Chairman, you were behind the curve in raising rates to fight inflation, and you said earlier, the full effects of our tightening cycle have not yet been felt. How will you decide when to cut rates, and how will you ensure you're not behind the curve there? >> JEROME POWELL: So, we're aware of the risk that we would hang on too long, you know. We know that that's a risk, and we're very focused on not making that mistake. And we do regard the two -- you know, we've come back into a better balance between the risk of overdoing it and the risk of underdoing it. Not only that, we were able to focus hard on the price stability mandate, and we're getting back to the point where -- which is what you do when you're very far from one of them, one of the two mandates -- you're getting now back to the point where both mandates are important, and they're more in balance, too. So, I think we'll be very much keeping that in mind as we make policy going forward.