Harkster Preview - FOMC

Today’s focus... What does Jay (soft landing) Powell need to do to be nominated as Time "Person of the Year"?

Consensus: Rates on hold, JPow to repeat the message he gave during his fireside chat at Spelman college (BIS)... #datadependent, #higherforlonger, flexibility to respond to the incoming data is key, balanced risks between UER/inflation and inflation has eased but it is still too high for too long. 

The economy has slowed from its Q3 peak to below par growth in Q4 without a material weakness in the labour market and a positive disinflation trend. As the soft-landing approaches, it begs the question, what does Powell need to do to be nominated as Time "Person of the Year"? 

The committee has refused to even talk about the prospect of cuts. Apparently, the Fed are wary of re-igniting inflation so they want to maintain a "higher for longer" stance to help cap financial conditions, but that same stance is now in conflict to the softening in data that has led markets to price 4/5 cuts next year. The markets repricing of the risk-free rate has already fuelled an everything rally (WSJ - When Bond Yields Dropped, the Everything Rally Kicked Off). So, what would now happen if the Fed simply agreed?

This conflict may well end at the March SEP when the Fed will have a better view on base effects, longer to understand the lagged impact of monetary policy, but the rates trade maybe over by then if it isn't already. For them to cut more than 4 times next year, will something have to break? Which leaves us navigating this evening's event - Fed will say there are 2 maybe 3 cuts next year in their 2024 dots, the mkt says no there won't be, we see 4/5 and ultimately, we are none the wiser, left waiting for the Q1 data set to confirm who is correct. Did the market get ahead of itself (again) or has the Fed been too slow to hike as inflation spiked and subsequently too slow to cut as inflation eased.... 

Given the natural bias for short term players is to look for a repeat of the Sept price action, higher dots = higher rates = higher USD, the risk tomorrow is the Fed actually marks to market and declares victory on inflation. It's unlikely, it would be a material surprise given they've tried to manage FCI throughout Q4 but such an outcome seems like it would have the biggest material impact on a portfolio. If their hawkish, and the mkt doesn't believe their dots, rates may sell off for a spell but the move is unlikely to hold as the Fed need to change their message materially to alter the mkt's forecasted cuts. 

Is it credible to be overtly hawkish, if we're trending towards rates becoming too "restrictive" should the decline in inflation continue. The market is simply looking 6 months ahead to cuts, curbing real rates in excess of 3% and has been guided there by Waller's pivot. "If the decline in inflation continues "for several more months ... three months, four months, five months ... we could start lowering the policy rate just because inflation is lower," (Reuters - With Fed likely done hiking rates, Waller flags pivot ahead)

This may be Powell's last chance to be hawkish and if everyone is also expecting the dots to push back against market pricing, where is the hawkish surprise coming from? Fed’s "data dependence" makes it very difficult for his rhetoric to push back convincingly against market expectations of an early rate cut.

Three potential hawkish surprises away from the 2024 dots...

1. Powell could make it clear that they're not currently talking about cuts

2. Could the long run be raised to 2.75%? This has been drifting higher and was a worry into Sept's meeting during peak bond vigilant season but it has long been forgotten during this swift Fi rally.  
   

3. Are financial conditions still considered "tight"? The infamous change to the last statement, will it be amended back?

   

   Source: Paragraph 2 - Federal Reserve issues FOMC statement Nov 01

What's in the price?

• Benjamin Picton, senior macro strategist at Rabobank via ZeroHedge - "So, the huge disparity between market pricing and the Fed dot plot continues. The dot plot median for 2024 is 5.125%, and the lowest value is 4.375%, while the futures market is suggesting that Fed Funds will finish the year just a touch above 4%. This suggests that every member of the FOMC would have to be wrong (or fibbing) about the likely future path of their policy rate decisions for the market to have it right."

Source ZeroHedge 

Harkster Decision Tree: 

The question is when and by how much the Fed will cut in 2024. The expectations are the 2024 dot will be at 4.63% or 4.875%, even the dovish hint is well above current market pricing of 4.21% for Dec 2024. So where is the long-term USD short squeeze going to come from unless the data is strong in Q1. Data will drive rate pricing not Fed dots or rhetoric... Higher dots to only have a 24-48hr impact (unless accompanied by a new Fed message)?

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Top Sources

Discovered on Harkster.com

Ten Fed Previews that have arrived in our curated Fed channel on Harkster.com: 

• Steno Research - POSITIONING WATCH – ARE MARKETS READY FOR POWELL WEDNESDAY?

• MacroHive - Fed Preview: On Hold Through 2024

• ING - We expect another Fed hold, but with pushback on rate cut prospects

• Employ America - December 2023 FOMC Preview

• BNP Paribas - A race between the ECB and the Fed?

• Calculated Risk - FOMC Preview: No Change to Policy Expected

• Claus Vistesen - Is a soft landing in the bag?

• FT - Claudia Sahm: it’s clear now who was right

• JPM - Does the November Jobs Report Point to a Soft Landing?

• The MacroTourist - The Reasons Why The Fed Blinked

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