CAMS Weekly View from the Corner - Week ending 3/22/24
March 25, 2024
Don’t let go – do not let go!
Tiger by the tail metaphor’s can be quite helpful in depicting a broad and complicated landscape relative to X topic. Our topic is very broad and can be complicated in light of the many tributaries it can elicit. We will stay narrowly focused to help in reducing complication.
This past week Chairman Powell’s Fed met for another interest rate setting gathering and as expected no changes were made in rates. Also as expected, Powell went full-on with “rate cuts are coming” at some undetermined downstream point. That is if price inflation works itself out downstream, along with additional qualifiers.
To the point, in doing our dissection of the post-meeting press conference transcript he offered: “We believe that our policy rate is likely at its peak for this tightening cycle and that, if the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year. The economic outlook is uncertain, however, and we remain highly attentive to inflation risks.” (Transcript of Chair Powell’s Press Conference March 20, 2024 (federalreserve.gov)
In a couple of short sentences the Chairman addresses multiple concerns from various points of view with some being counter to others. For example, the “highly attentive to inflation risks” offering may turn out to be higher interest rates if price inflation chooses not to follow the hoped for script. This would axe their belief that their policy rate is likely at its peak.
The Chairman has a tiger by the tail and it seems he is well aware of such and accordingly is doing everything to appease the tiger while firming his grip on the tail.
The tiger here is the general and broad market(s) landscape. The tail that he is holding in order to keep the tiger at bay is the loosening of financial conditions by economic/market participants brought on by Powell’s consistent verbalization that “rate cuts are coming.”
When the metaphorical tiger was in its infancy he did not set it straight with “rate cuts are not coming” until we see price inflation is solidly under control, not speculatively under control. This essentially boiled down to, how long ago now, we think this inflation thing is all but under control so therefore we will entertain rate cut discussions on a downstream basis. That consistent messaging let the tiger grow wildly – think broad market landscapes trending straight up.
He has to firmly hold onto that tail (verbalize downstream rate cuts) in order to keep the tiger from turning on him.
The tiger turns on him in the form of markets taking away their built up expectation of cheap Fed dollars arriving “any month now” (think rate cuts) resulting in down trending markets as a result of recalibrating interest rate cut expectations on the part of collective market participants.
As an important aside, those downstream interest rate cuts were supposed to have begun at this meeting per consensus views several months ago.
What got in the way? Price inflation.
Recent reports have not been behaving according to the expected script. Simply, they are not going down as needed. As a result concerns have been building, albeit subtly, that we may have a problem here with the built in Fed cuts throughout markets.
About Those Loosening Financial Conditions
We have been offering the topic of loosening financial conditions by broad market participants within various editions for numerous months now.
The overriding theme/question in our editions offering the topic has been quite simple: Can we see this price inflation era be put to bed while financial conditions have been consistently loosened by broad market participants which effectively acts as though interest rate cuts have already begun?
Interestingly, this question has been building momentum in recent time as the gist of the question is generally asked more frequently and specifically to the Fed itself.
Let’s go back to the Chairman’s press conference from last week as we share a section of Q&A.
NEIL IRWIN. How do you assess the state of financial conditions right now and particularly, in particular do you view the kind of easing financial conditions since the fall is consistent and compatible with what you're trying to achieve on the inflation mandate?
CHAIR POWELL. So we think, there are many different financial conditions indicators and you can kind of see different answers to that question. We saw, that's been a question for a while, we did see progress on inflation last year, significant progress despite financial conditions sometimes being tighter, sometimes looser.
Staying true to our outset message we will keep this edition narrowly focused realizing the topic of broad financial conditions can invoke many tributaries and through this complication. With this aim we reduced the Chairman’s answer down to the broad scope of general financial conditions.
We can see he consistently offers a past tense focus which when doing so is quite fair. The problem is over the previous year, as financial conditions were tighter, along with Fed messaging by-the-way; price inflation was making a consistent retreat.
As the previous year has morphed into the recent six months and then recent three months financial conditions have loosened considerably and interestingly with this, the retreat of the growth rate of price inflation has stopped.
In recent months he has been consistent in his messaging that there are many different indicators of financial conditions that give different answers which is certainly true to the point of being a non-topic.
What is debatable and concerning is how more and more of the different indicators have fallen onto the “loosening” side of the ledger.
We sense that was the gist of the question posed to the Chairman. For Powell’s part he delved briefly into the employment market and tributaries within it and then went broad again finishing with “….financial conditions sometimes being tighter, or sometimes looser.”
The National Financial Conditions Index
Below is the description of a broad National Financial Conditions Index and its accompanying chart which is offered from the Chicago District bank of the Federal Reserve. We underlined the key measures to emphasize the broad scope this index covers.
The Chicago Fed's National Financial Conditions Index (NFCI) provides a comprehensive weekly update on U.S. financial conditions in money markets, debt and equity markets and the traditional and "shadow" banking systems. Positive values of the NFCI indicate financial conditions that are tighter than average, while negative values indicate financial conditions that are looser than average.
Above is a decade chart of the broad financial conditions index for some recent historical perspective.
Our left red up arrow highlights the solid uptrend that was occurring with interest rate hikes and strong messaging from the Chairman and his Fed.
Our right red down arrow highlights the solid downtrend of late. This downtrend has been occurring with no interest rate cuts as broad participants have been acting on softer Fed messaging and have taken action as though rate cuts have already begun.
The downtrend arrow begins last March (2023) and reflects how it has increased in downside momentum. In addition, while looking at the decade chart in its wholeness, note current financial conditions relative to the past decade. We clearly are not pressed against a proverbial wall of tight financial conditions relative to the decade depicted.
With all of the above offered Chairman Powell has a tiger by the tail.
He has messaged too consistently that an easier Fed via rate cuts are coming and consequently broad markets across the spectrum have become a tiger in light of their elevated levels in light of the assured expected rate cuts.
With this financial conditions have notably loosened while the previously assured price inflation downtrend is becoming questionable.
Near-term months of price inflation releases will be very important.
The Chairman will only be able to appease markets for so long before they grow restless and will need more than words to convince them that both price inflation is dead and rate cuts are a thing versus a downstream expectation of such.
I wish you well…
Ken Reinhart
Director, Market Research & Portfolio Analysis