Today will be the first time in my career that there wasn’t an obvious, expected outcome of the Federal Reserve’s Open Market Committee meeting. That makes it very exciting, but harder to trade. As always, there are three possible categories: hawkish, dovish and what’s expected.
The last one is the tricky part here. How do we zero the scale? What exactly does the consensus expect Powell to do? Normally, it’s just whatever he said he would do the last time he spoke, which in this case was an intimated 50 basis-point hike. But he also said he is data-dependent, and inflation went in the opposite direction he hoped since he last spoke. As a result, the Fed funds futures market says he’ll hike at least 75 bps. The majority of strategists surveyed by Bloomberg also are betting for 75.
Attentive readers of this newsletter will know I argued for a hawkish surprise the last time Powell was on deck in May. Go back to FOMC that first week of the month to get clues on how the market might respond today.
The bond market heading into May FOMC had a 75-basis point hike priced in for July. But the Fed Chair chose to strike a more dovish tone, and instead implied that the current rate of 50 bps should suffice through the summer. Yields dropped and stocks rallied during the press conference…. but didn’t get far. Stocks dove overnight, the 10-year yield ripped through 3%, and the S&P 500 made a year-to-date low by the weekend.
In other words, Powell’s dovish decision induced volatility across almost all assets. That’s a brand new kind of response by the standards of the past decade, when asset prices always responded kindly to incrementally easier policies. If you consider market volatility to be a representation of uncertainty or weakness in the economy, then the market’s been giving the Fed Chair a clear warning the past month that he’s not doing enough and needs to get more hawkish.
But it’s hard to know when to trust “the market.” That’s exactly what Powell did when he cut rates during a steady economy in 2019, a decision that I believe spurred the start of an equity bubble. It adds quite a bit of mystery to today’s situation: why did Powell obey the bond market in 2019 but is choosing to dispute its wisdom now? Does he regret the outcome of that earlier decision? Were bonds crying wolf then, or are they now?
This is a really tough one. But I think he should go for at least 75. We need to find out if our weapon to fight inflation even works, and you can’t do that if you don’t give the market what it says it can handle. We saw the results from 2019 when we did what bonds told us to and cut; now we need to see what happens when we flip the switch the other way. Let’s see what breaks, and hope it is inflation.
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