The Breakdown - The Hawkish Halt: Why the Market Finally Believes "Higher for Longer"

Episode Date: September 22, 2023

Today NLW digs into the FOMC decision to keep rates consistent and explores why many are causing it a hawkish pause and recognizing that the Fed really is going to keep rates higher for longer. Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Thursday, September 21st, and today we are going macro, talking about the FOMC conference, what it means, where in the cycle we are, but before we get to all of that, if you're enjoying the breakdown, please go subscribe to it, give it a rating, give it a review. Or if you want to dive deeper into the conversation, come join us on the breaker. Discord. You can find a link of the show notes or go to bit.ly slash breakdown pod. Well, friends, hallelujah, we have an episode that is not about Binance or the SEC.

Yes, today we are talking macro. And I have to say, it feels like we are in the culmination of a phase. We know that we are close to the top from an interest rate perspective, but we don't know if we're actually there. We don't know how real economic conditions are going to change things. We certainly don't know when we're going to start heading the other direction and having rates come down, and we're still living in this weird limbo where things don't feel great, but we aren't in a recession. And so you take all of these factors together, and I think that people were watching this fomc meeting just a little bit more closely than we have for the last few. The TLDR on what actually happened is that Federal Reserve officials

decided to hold rates steady between 5.25 and 5.5%. Now, this is the second straight meeting with no change in policy settings, with the Fed funds rate remaining at 22-year highs. And And because there is always a key word or a key phrase when it comes to these FOMC meetings, this one was definitely proceed carefully. During his press conference, Fed Chair Jerome Powell emphasized that despite strong economic data since the last meeting, the FOMC were in a position to, you guessed it, proceed carefully. Now, this phrase was repeated six times throughout media questioning, always to some extent

around an assertion that the committee didn't need to make any decisions quite yet about what was coming next. Talking about the committee, Powell said, really what people are saying is let's see how the data come in. They want to be convinced. They want to be careful not to jump to a conclusion. Fed whisperer Nick Timoros, Chief Economics correspondent at the Wall Street Journal said, Powell used the words proceed carefully six times during Wednesday's news conference, a sign of heightened caution about lifting rates. Forward guidance host Jack Farley said, The last time Powell used this language in his speech before taking questions was March 23.

and this was in the context of monitoring potential tightening of credit conditions post-SVB. So adding a little more meat to this proceed carefully bone, Powell stressed that taking no action right now was the most prudent choice at this stage of the inflation fight. He said, quote, inflation has moderated somewhat since the middle of last year, and longer-term inflation expectations appear to remain well anchored. Further, he said, as we get closer to the stance of monetary policy that we think is appropriate to bring inflation down to 2% over time,

the risks become more two-sided, and the risk of overtightening and the risk of under-tightening becomes more equal. I think that the natural common sense thing to do is, as you approach that, you move a little more slowly as you get closer to it, and that's what we're doing. And you get here kind of why I'm saying that we're at the crescendo at this stage culmination kind of moment. But what's difficult for people is, of course, that what Powell is doing as we get closer to coming into the station is he's reducing the speed. Now, alongside the rate decision, the meeting also included the publication of the quarterly summary of economic projections or SCP. The SEC contains a range of forecasts from FOMC members on the future path of rate policy,

known affectionately as the dot plot, as well as a range of other economic projections. The dot plot showed that 12 of the 19 Fed officials had penciled in one additional rate hike by the end of the year, meaning effectively a split decision on whether the Fed should call an end to their tightening cycle. Now, when asked about rates and whether we're in restrictive territory, Powell said, the fact that we decided to maintain the policy rate at this meeting doesn't mean that we've decided that we have or have not at this time reached that stance of monetary policy that we're seeking. If you looked at the SEC, you will see that a majority of participants believe that it is more likely than not that it will be appropriate for us to raise rates one more time

in the two remaining meetings this year. Now, beyond that specific note around one more hike, the main takeaway from this set of forecast was also that rates would remain higher for longer. Rate expectations for 2024 were bumped up slightly, with the median forecast coming in at 5.1%. And this represented a 50 basis point increase from the forecast published in the June SEP. Putting it a different way, that means that only two rate cuts are expected to be necessary next year, rather than the four which were previously forecast. Core PCE inflation was forecast to fall to 3.3% to close this year and moderate further to 2.5% across 2024. With inflation forecast to moderate faster than the FOMC expects to cut

rates that would signal an intention to hold the Fed funds rate in restrictive territory until at least the end of next year. Rounding out the numbers from the SEP, GDP growth is forecast to moderate, finishing the year at 2.1% and reducing to 1.5% for next year, and unemployment is forecast to only rise slightly alongside this growth slowdown, leveling out at 4.1% over the next two years from its current level of 3.8%. Now from here, let's get into some of the topics that were most hot button and ran throughout the presentation and the press conference after. One of the the big topics was, of course, the fabled soft landing. This set of projections is a long way from the dire forecast from just a few months ago. At the August meeting, Powell disclosed that Fed staff

had been predicting a recession. This time, while definitely not a booming economic projection, the small uptick in unemployment while growth and inflation moderate were essentially forecasting a soft landing. When asked if a soft landing is his baseline expectation, Powell stated, quote, I would just say, I've always thought that the soft landing was a plausible outcome, that there was a path really to a soft landing. Ultimately, this may be decided by factors that are outside our control, but I do think it's possible. Still, Powell made sure to emphasize where the FOMC's real focus was. He said, the real point is that the worst thing we can do is fail to restore price stability, because the record is clear on that. If you don't restore price stability, inflation comes back,

and you can have a long period where the economy is just very uncertain, and it'll affect growth, it'll affect all kinds of things. It can be a miserable period to have inflation constantly coming back, and the Fed coming in and having to tighten again and again. So the best thing we can do for everyone, we believe, is to restore price stability. Now, numerous commentators picked up on the soft landing narrative. Jan Hatsius, the chief economist at Goldman Sachs said, they're worried about taking a victory lap too early, obviously, but these forecasts are soft landing adjacent. Former Fed Governor Lawrence Mayer said of the prospect of bringing inflation down without a major rise in unemployment, this would be a beautiful outcome. You'd be in macroeconomic heaven.

He said that the forecast, quote, looks optimistic, but I basically agree with it. Now, for anyone hoping to get information about future cuts, good luck. Powell said the time will come at some point, and I'm not saying when, that it's appropriate to cut. Part of that may be that real rates are rising because inflation is coming down. Part of it just may be that all the factors that we see in the economy. That time will certainly come at some point. What you see us writing down a year ahead estimates of what that might be. There's so much uncertainty around that.

Now, although the projections laid out a pathway for a soft landing, there are still numerous factors standing in the way. Inflation numbers for August showed a slight uptick in inflation driven by higher oil prices. The latest GDP estimate for Q3 provided by the Atlanta Fed's GDP Now model showed real GDP running at an elevated 4.9% annualized rate. And why that matters is that Powell had previously been clear that he believes that a return to the 2% inflation target would require a period of below-trend growth. Importantly, that phrase was noticefully absent from yesterday's press conference. Powell instead said that, quote, GDP is not a mandate. Maximum employment and price stability are the mandates. The question will be

is the heat that we see in GDP, is it really a threat to our ability to get back to 2% inflation? That's going to be the question. It's not a question about GDP on its own. Still, regarding the recent run-up in oil prices, Powell didn't appear to think they were a problem over the short term. He said, quote, energy prices mostly don't contain much of a signal about how tight the economy is, and hence don't tell you much about where inflation is really going. However, if energy prices increase and stay high, that'll have an effect on spending, and it may have an effect on consumer expectations of inflation. Putting a fine point on all of this, Bloomberg economist Anna Wong said, even though the dot plot shows another hike this year, we see a number of potential adverse

shocks to growth between now and year end that could derail that plan. Economic uncertainty and disruptions from the UAW strikes and looming government shutdown may push the Fed to postpone a hike to 2024 or even nicks it completely. Now, as I discussed at the top, one of the weird things about right now is that although there are these strong arguments that we are headed towards a soft landing, basically the best case scenario for the environment that we found ourselves in, people hate this economy. Recent surveys have shown that consumers just don't feel satisfied with the state of where things are. Now, of course, many explanations have been offered, from sky high rates on new mortgages, freezing up the housing market, to wage gains failing to

keep up with inflation. Powell had a slightly different take saying, quote, surveys are showing dissatisfaction. I think a lot of that is just people hate inflation. They hate, it. And that causes people to say the economy is terrible. But at the same time, they're spending money. Their behavior is not exactly what you would expect from the surveys. Now, one more theme from the press conference is sort of a little bit of a zoom out, and that's the idea that the neutral rate might simply be higher in the post-pandemic economy. The neutral rate is, of course, the level of interest rates which is neither supportive or restrictive of growth. Richmond Fed President Tom Barkin recently said, conceptually, if the economy is running above potential at 5.25% interest

rates, then that suggests to me that the neutral rate might be higher than we've thought. Powell even touched on this theme during the press conference saying, in terms of what the neutral rate could be, we know it by when it works. Ultimately, you only know when you get there and by the way, the economy reacts. It's certainly plausible that the neutral rate is higher than the longer run rate. Now, the big takeaway for markets was a settling in of what the Fed has been saying for quite some time, which is that rates will be higher for longer. Despite that being the position of the FOMC for most of this year, markets have basically doubted the Fed's ability to hold rates at such elevated levels. In the wake of the press conference, bond markets quickly adjusted to the

new dot plot, which showed rates being held above 5% well into next year. The two-year treasury yield touched 5.2% during yesterday's session, which is its highest level since 2006. Fed Fund's futures are now pricing a 5% rate until October of next year. Art Hogan, the chief market strategist at B. Riley Wealth said, if you were really looking for the worst piece of news, it's not necessarily that we're going higher, but that we're staying longer. That's the new narrative. It's not how high, but how long. Hogan is referring to hire for longer being bad news specifically for equities, which have enjoyed a blistering hot year on the back of course of the AI trend, and also a common

belief that rate cuts were right around the corner. Given that, perhaps not surprisingly, the S&P 500 slid by 0.9% on Wednesday. That was the second worst Fed Day performance of the index this year, behind only the March meeting which was held in the midst of the Silicon Valley bank collapse. Bitcoin fell 1% during the press conference before regaining the loss during the afternoon. Still, those levels couldn't hold and the price ultimately fell to 26,700 overnight. Crypto and macro analyst Noel Atchison summed up the meeting like this. The big news is the 2024 rates projection, which is higher than I expected.

This is a very big signal. It's the message sent by effectively taking two rate cuts off the table, which also suggests that any rate cuts will come later than the market had been hoping. She added that higher rates, a stronger dollar, and stock market drops are not good for Bitcoin. So in many ways, this is really the first time this hiking cycle that we've seen market participants believe the Fed's higher for longer forecast, despite the fact that they've been saying it all year long. 58% of respondents to a Bloomberg Market's live survey said that two-year treasury rates are yet to peak even after reaching 17-year highs.

And that gets us to the phrase that the market has used to digest this news, which is hawkish hold. Macro-analyst Aisha Tarik said, As expected, the Fed skips the hike for this meeting in what everyone is terming a hawkish. hawkish pause. The dot plot is interesting with one more hike projected for 2020. 2024 rate projections show only 50 basis point cuts for the next year. We had estimated this being dropped to 75 basis points. The Fed's projecting quite the hawkish path proving us wrong. City Group economist Andrew Hollandhurst said, Chair Powell and the Fed sent an unambiguously hawkish hire-for-longer message at today's FOMC meeting. The Fed is projecting inflation to

steadily cool while the labor market remains historically tight. But in our view, a sustained imbalance in the labor market is more likely to keep inflation stuck above target. Alexander Wilson, Elon Zondo, Deputy Chief Investment Officer of Multi-Asset Strategies at Goldman Sachs Asset Management said, the release was more hawkish than expected. While a share of past policy tightening is still in the pipeline, the Fed can go into wait-and-see mode, hence the pause. However, the main risk remains tarnishing their largest asset, anti-inflation credibility, which warrants favoring a hawkish reaction function. By and large, that was the big takeaway, but there is one other thing that I wanted to make note of. And that was a few people commenting on Powell's demeanor.

Analyst Andy Constan said, Paul seems scared and guilty like he knows he broke something and doesn't want to admit it. Tracy's shoe chart said, this is the worst presser I have seen from Powell. He is contradictory and he comes off very unsure. Or maybe the press is actually asking real questions and it's making him nervous. No doubt there will be much speculation around what that nervousness might represent. But for now, we've got higher for longer in a hawkish hold, and that was the story of the FOMC. Later this week, we will talk more macro with what's going on in oil, but for now, we are going to wrap it there. I appreciate you listening as always, and until next time, be safe and take care of each other. Peace.