The new “Powell Pivot” might be one towards becoming the next Arthur Burns and not the next Paul Volcker. Arthur Burns, as you may or may not know, was the Fed Chair most associated with the rampant inflation of the early 70’s; the same inflation that Volcker famously (and painfully) snuffed out during his tenure.
The latest Fed meeting contained the usual obfuscation and Fed speak, however the Chairman gave a few non-specific, specifics. Powell maintained a high degree of confidence that the Fed would get inflation down to the 2% target, and anticipates that there will potentially be three rate cuts during 2024…data permitting. The question that we are asking is: Why are they even talking about a rate cut at this stage in the cycle, particularly given the fact that financial conditions have been easing for the last eight months as measured by the Effective Fed Rate?
The Effective Fed Rate is the change in the policy rate that the market has effectively priced in. The rate is an amalgamation of: The policy rate + its expected change over the next year + the one year change in the GS Financial Conditions Index. This rate has been falling at a steeper pace than at any time over the last 30 years. The Fed’s mindset is particularly puzzling as this rate is rising just prior to the Fed easing policy. Therefore, the Fed is planning on potentially easing into a market that clearly doesn’t need it.
What is most curious (and reckless), in our opinion, about the Fed’s latest stance on inflation is that they are assuming that the strong inflation data we are experiencing in 2024 is mostly due to seasonal factors and one-offs. In fact, Powell recently stated “We aren’t completely put off by the bad inflation data in January and February”. While you can slice and dice price data any way you like, it is hard to envision inflation gently falling into the 2% sweet spot with labor markets still tight, geo-political tensions still running high and overall growth projected to remain in the 3-4% range.
The very real possibility of the Fed making an unforced error here is causing renewed concern as measured by the latest Fund Manager Survey. While inflation may have replaced geo-political concerns as the major tail risk concern, there is little evidence that these same managers are positioning themselves accordingly. A look at those same managers' positioning shows that it remains bullish.
Takeaways: From the same folks that brought you “transitory”, Chairman Powell assured us this week that they know what they are doing when it comes to inflation. Lowering rates into a system that is absolutely awash with liquidity should not surprise anyone. This organization has a long history littered with doing the wrong thing and subsequently mopping it up with unconventional monetary science experiments.
Absent any substantial decline in the broader economy, the first rate cut by the Fed will represent an important inflection point in the bond market; one in which rates (primarily at the long-end) will far surpass the most recent highs.