CAMS View from the Corner
November 19, 2024
It is very important to realize that when a member of the Fed speaks, in particular its Chairman, every word is scripted to the Nth degree as they are well aware the words they utter will be dissected, analyzed and dissected some more. This is especially true relative to prepared remarks.
The preparations of said remarks are scrutinized for their ultimate interpretation by collective market and general economic participants before they are ever spoken in public. Verbal and written messaging is a tool used by the Fed knowing market and economic participants will act on their messaging. This is known as “jawboning” which is a tool nearly as important as actual policy changes.
If you are even an occasional reader of these editions you will recognize we have been full-on questioning of why were we even talking about cutting interest rates and then morphed that questioning into why are we actually cutting interest rates as the Fed moved into that policy shift.
To underline this let’s revisit last edition’s header quote from Chairman Powell himself where he offered a succinct layout of the economic landscape. This was excerpted from his press conference after the Fed cut interest rates for the second time within the past six weeks.
“Recent indicators suggest that economic activity has continued to expand at a solid pace. GDP rose at an annual rate of 2.8 percent in the third quarter, about the same pace as in the second quarter. Growth of consumer spending has remained resilient, and investment in equipment and intangibles has strengthened. In contrast, activity in the housing sector has been weak. In the labor market, conditions remain solid.”
Transcript of Chair Powell’s Press Conference November 7, 2024 (federalreserve.gov)
Last Thursday, November 14th (just eight days after the above referenced press conference) Chairman Powell presented prepared remarks in Dallas and then sat with a moderator for a Q&A session.
In his prepared remarks he offered near verbatim language as he did at the aforementioned press conference both on the economic landscape as well as the Fed’s expected approach toward assessing incoming data relative to future rate cuts.
One line was added that caught market participants off-guard because it was completely new and seemingly came out of nowhere relative to their consistent messaging leading up to the first rate cut on September 18th to include any messaging since then.
“The economy is not sending any signals that we need to be in a hurry to lower rates.”
Speech by Chair Powell on the economic outlook - Federal Reserve Board
What!?!? That was the tone and reaction of general market participants most notably stock market participants as they hit sell buttons upon hearing this new addition.
Underlining the fact that nothing has changed economically from eight days ago as well as six-plus weeks ago when it became a foregone conclusion the Fed was about to embark on an interest rate cutting cycle, Chairman Powell, as offered above, referenced the same data points in describing the general economic backdrop.
Strangely, now when assessing those same data points the above one sentence quote was added to the mix of the Fed’s forward view of their expected rate cutting pathway.
What Changed?
Well there was an election of course. Economically speaking nothing changed – as offered the same economic landscape has been described by the Chairman anytime he has communicated.
For our part we have felt this whole storyline offered the potential for downstream market and potential economic volatility.
Our volatility trap concern, succinctly offered goes like this as a general scenario:
The general economic landscape offered no need for interest rate cuts, including in particular the price inflation backdrop.
The Fed cuts regardless and signals (i.e. jawboned) a Rate cutting cycle had begun. Price inflation in particular doesn’t play along to the point of reestablishing an uptrend which the Fed then has to acknowledge via changing course from cutting to raising interest rates.
Simultaneously, participants throughout markets as well as general economic players act with an expectation of rate cuts continuing.
They then have an “oh oh” realization that Rate cuts will not be coming and worse, Rate hikes may be in the offing in light of the general price inflation backdrop not playing along as expected.
In the most basic form of describing our above volatility concern think stocks get pumped up on Rate cutting cycle expectations then the air is let out on a shift from the Fed in the opposite direction upon realizing the price inflation issue has not be resolved.
Fed history itself offers this storyline circa 1979 through 1982 as an example.
Briefly sharing they felt the price inflation issue was retreating to the point that interest rates could be cut. They were wrong and through their error had to turn in the opposite direction and raise rates much higher than they had been at the prior peak. This became known as the “Volcker Mistake.”
All markets were thrown into a tizzy while the stock market in particular went into literal full roller coaster mode for nearly three years. It went up and then back down rinse and repeat.
The Antidote
In our view the antidote to the above potential storyline playing out has been to simply let the general economic story play out further keeping interest rates “higher for longer” eliciting what had become a well recognized phrase in the economic/Fed lexicon.
The general economic landscape has been in growth mode while price inflation has slowly improved but certainly has not been conquered if you will.
At the same time, underneath this economic growth mode has been the well known situation of massive Treasury budget deficits playing a role in the growth.
The concern from this is a feedback loop to price inflation issues from these deficits. Adding monetary grease to this backdrop via Fed Rate cuts is getting too close to literally asking for price inflation issues to resurge.
With all of the above the mere addition of the one line from Chairman Powell last Thursday added instant volatility by market participants as they work to recalibrate what Fed policy is actually going to look like near-term.
They heard the new additional messaging and began to hit sell buttons. They did so in some areas of the stock market much more so than others. For their part interest rate trader’s immediately reduced probabilities of their previously expected Rate cutting pathway via the CME FedWatch tool.
The Fed has now messaged a new addition to the forward view that perhaps Rate cuts will not be occurring to the degree as previously inferred and that which had become expected by general participants.
This is neither a certainty nor a prediction but our in-house concern remains that all of this is inviting unnecessary potential volatility.
Late last week we seen just a touch of what that can look like which occurred with only a small addition to the Fed’s messaging. Imagine what it would look like if they were forced to do a full retreat, or worse, move in the opposite direction to actually raising interest rates again ala 1979 through the very early 1980’s.
Stock market participants immediately took note of the Fed’s new stance late last week. That could be but a microcosm of what would happen if the Fed has to turn in the opposite direction because they realize they began cutting interest rates too early and in so doing rhyming with history via the late 70’s and into the early 80’s.
I wish you well…
Ken Reinhart
Director, Market Research & Portfolio Analysis
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