- Powell said there is a lot more work to do
- Expect at least one more hike this year
- And only two rate cuts in the second half of next year
Let’s start with a quick quote from yesterday’s missive:
“From mine, Powell will deliver a hawkish tone leaving the door wide open for further hikes in November or December if needed”
That’s exactly what he said.
From my lens, Powell sounded hawkish today – reminding investors they are are not done hiking.
Not yet.
And if I’m to be blunt – he has sounded hawkish at every meeting this year.
But investors will often choose to hear what they want to hear.
Be conscious of what biases you have.
What’s more, the Fed doubled down and reduced their expectations for rate cuts next year – indicating there may only be one or two in the second half.
Previously the Fed indicated this could be as much as 75 bps.
Put another way – the script is higher for longer.
That was at odds with the market’s expectations for around 100 to 125 bps of rate cuts in the second half.
And ideally – the market didn’t want to see another hike to close 2023.
Net result – stocks sank and bond yields continued their ascent.
You might say things went ‘per the script’.
Then again, some may have been expecting a different result.
Not me.
Not all Bad News
Whilst Powell stressed the Fed needs to remain vigilant – he did raise their growth outlook.
That’s a positive.
In fact, because the Fed raised their growth outlook (this year and next) – this also gives them scope to be more hawkish.
Call it ‘bullish hawkishness’ (if that’s even a thing?)
And whilst inflation is slowly coming down – Powell believes they will win the fight over time.
However it won’t be in 2024. And maybe not in 2025.
But it will eventually work its way back to 2.0%
I think that’s reasonable.
Remember:
Tectonic forces such debt and demographics are deflationary.
However, what gives the Fed room to keep rates higher is a stronger economy.
And that’s what he sees (for now).
Then again, be careful to read too much into any Fed forecast (it’s not their strong suit)
For example, the Fed also saw a strong economy going into 2008.
Towards the end of 2007 – unemployment was very robust 4.0% and GDP had seen three consecutive quarters of near 2.5%
We know what happened next.
For now, the Fed members remain optimistic that next year will see strong growth and employment.
And given they think inflation will largely be benign – that’s your soft landing script.
Bond Yields React
Take a look at what we saw with the US 10-year yield after Powell spoke (using the daily chart):
Sept 20 2023
At the time of writing – the 10-year is now 4.435% – and likely headed higher.
For me – this is the story.
Forget stocks.
Yields are telling you this going to be a higher for longer environment.
But the question I have is can the economy (and stocks) tolerate a 10-year yield around 4.50%?
Or closer to 5.0%?
For example, we saw the sharp sell off in tech stocks today.
That was entirely due to what we saw with yields
Long duration assets (like tech) will get pummelled as yields go higher – as their cash flows are discounted.
But let’s come back to the Fed decision…
If the Fed is looking to raise rates further (and keep them there) – with inflation coming down – it means real rates are moving higher.
And that’s going to pressure the economy
For example, Powell talked about a “higher neutral rate” in his language.
There is a view that they’re going to have to keep real rates a little higher for longer to get the inflation out of the system.
And the challenge will be how they do this with the growth outlook.
Putting it All Together
In closing, 12 of 19 Fed committee members said they expect to raise rates again this year
The market had not priced that in.
Anyone remember (widely followed) Barry Ritholz saying “the Fed is done” (on the basis unemployment hit 3.8%)
I countered by saying that’s far too premature.
Sorry Barry old mate – the Fed is not quite done.
Closer.
But not there yet.
Fed projections for next year show that committee members expect the key rate to be 5% at the end of 2024
This implies just two rate cuts next year (much higher than expected)
Again, this wasn’t priced in.
Last week the market was pricing in a minimum of four (and potentially five) cuts next year.
Powell told reporters that while there clearly has been progress in the effort to reduce inflation, he wants to see “convincing evidence” that the central bank has gained the upper hand before deciding that interest rates are high enough – or, as he put it, “sufficiently restrictive.”
Exactly.
With Core PCE at 4.2% (and now WTI Crude rising towards $100/b) – that’s far from “convincing evidence” they have the upper hand.
Powell added:
“The process of getting inflation sustainably down to 2% has a long way to go. We’ve seen progress, and we welcome that, but we need to see more progress”
My sentiment exactly.
Powell will not declare victory until he stares at the white’s of inflation’s eyes.
As I said yesterday – the market should focus more on when the Fed announces they are finished hiking (vs trying to forecast rate cuts).
We are not quite there yet.