FOMC Action: Preemptive Strike for Payroll?
The FOMC opened up the easing cycle with -50 bps, the same size as Jan 2001 and Sept 2007 despite much firmer macro ground today.
Why 50 basis points? Why not?
We imagine the front-end inversion was so glaring that the FOMC decided to move more notably on the fear it had hung on for too long at current rates since there has never been anything quite like the current UST shape in past cycles with steady growth and such a decline in inflation.
After getting hammered for being too slow in 2021 and now being a few months past the 1-year anniversary of their last move, the swing to -50 bps and charting a course to a median 4.4% by year end was an eye opener.
Current fed funds and inflation still leave room for more accommodation while keeping real fed fund rates positive into 2025 with room to maneuver into the 3% range if inflation cooperates.
With all but 2 of 19 dots now below current levels for yearend 2024, the debate was not too tough it appears at 11-1 with 1 voting for -25 bps.
The dual mandate is an easy enough justification on the grounds that you need to move ahead of any payroll problems, so that allows the market watchers to embrace or criticize Powell’s murky explanation and move on to openly discuss payrolls and inflation but very quietly ponder some very big issues ahead in the form of tariffs (the purview of the President) and the dollar (the Dept of Treasury’s turf). Both of those will be inflation factors.
We update the “fed funds minus headline PCE” chart as a reminder of how much room the FOMC still has to play with in positive real fed funds rates as a tightening strategy. Pro forma for the -50 bps today, there is still over 2 points of wiggle room (estimated +2.4 points excess with the current cut). The Fed still has ample room vs. the long-term median of +1.1 point real fed funds differential noted in the chart.
The “fed funds minus PCE” cushion is less than what we saw for the median in the inflation wars period (1973-1986) when the median was +3.3 points as noted in the chart. Those were very ugly periods with severe inflation and stagflation spikes. The painful bouts of inflation in the early 1970s, late 1970s and early 1980s were in a different world until Volcker went wild (see Inflation: Events ‘R’ Us Timeline 10-6-22, Misery Index: The Tracks of My Fears 10-6-22).
The move to a 4.75% to 5.0% range today sent stock prices initially into vertical, but then faded with the large cap benchmarks ending in the red. If “sell the news” was a drinking game, there would be a lot of folks turning in their car keys on the equity side.
The reality is the world gets back to business tomorrow with a still-inverted curve from 3M to 5Y and 3M to 10Y. Decisions will need to be made on moving out of cash into other asset classes or taking more duration risk on term premiums that get held up against the lowest yield curve seen outside the post-ZIRP and normalization years (see Footnotes & Flashbacks: State of Yields 9-15-24).
The dot plots and forecasts tell a story of more easing…
The focus on employment worries in the easing decision was backed up in the revisions with the median unemployment rate for year end 2024 up by +0.4% to 4.4%. The GDP expectations for the full year 2024 are mired at 2.0% (down 0.1% from the June forecast) with 2025 still hanging around at +2.0% and no recession.
The forecasts show fed funds at +3.4% for 2025 and inflation at +2.1% (down from +2.3% in June). The magic 2.0% is reached in 2026. For those keeping score at home, Trump’s greatest economy in history (as pitched by Mike Johnson on CNBC this morning) was a 2% GDP term. Mike missed the 80s and 90s apparently (and perhaps did not bother to read about them while in college and law school in the 90s at LSU).
The dot plots showed all 19 below 5% with the highest midpoints showing only 2 dots right where we are now with the -50 bps cuts. The biggest cluster is the 4.375% midpoint with 9 dots followed by the 4.625% midpoint with 7 dots. We saw 1 dot at 4.125%.
We were listening to some FOMC watching economists discuss the move after the fact, and we were perplexed when one assumed that mortgage rates would come down in lockstep with fed funds. Longer rates went higher and shorter rates lower on the day, so there will be plenty to discuss on that front. With two candidates destined to spike the deficits, that parallel move for mortgages by that subset of talking head economists is one heck of an assumption (we don’t see it that way) to expect a parallel shift out to 10Y UST rather than a partial steepener.
Why 50 bps instead of a staggered series of 25 bps?
The utter weirdness of such a protracted and steep inversion for so long in the face of reasonable GDP growth (in post-2000 GDP context) with 3% for the latest 2Q24 revision had to weigh on the FOMC. While payrolls are the worry, the very high absolute level of payrolls and JOLTs numbers despite the 4% handle unemployment rate is an odd mix in a move of -50 bps right out of the chutes (see 2Q24 GDP 2nd Estimate: The Power of 3 and Cutting 8-29-24).
That -50 bps start of the easing cycle is in line with that seen in Jan 2001 and Sept 2007. The Jan 2001 cut of -50 bps (to 6%) came as a very mild downturn was rolling in (mildest recession in postwar history) but with a lot of market and financial sector turmoil after the TMT bubble burst.
The other comp is the -50 bps cut in Sept 2007 (to 4.75%) as that downturn and material credit market turmoil and unfolding mortgage nightmare had a fuse burning (reminder: the recession started in Dec 2007 and the end of the world was nigh by Sept 2008). Those two periods were very different. That said, the post-COVID markets have brought the first inflation spike and tightening war since the Volcker years (the 1994 FOMC ambush did not qualify), and that was always going to make this cycle a distinctive one for monetary policy and inflation.
What next?
The expectation and handicapping drill about another -50 or -75 from here in 4Q24 starts the mindreading and data watching anew. Powell opined on why the Fed needs to stay independent, but the election risks did not come up. No one will wade into the risks of tariffs on price stability and employment from any such new policies. The “bid-offer” on post-election economic policies is something you can drive a fleet of trucks through, so there will be no shortage material X-factors to handicap come November about how the market might view 2025. That’s not the FOMC’s turf (at least openly).
See also:
Home Starts Aug 2024: Mortgage Rates to Kickstart Hopes Ahead? 9-18-24
Footnotes & Flashbacks: Credit Markets 9-16-24
Footnotes & Flashbacks: State of Yields 9-15-24
Footnotes & Flashbacks: Asset Returns 9-15-24
A Strange Policy Risk Week: Mini Market Lookback 9-14-24
Consumer Sentiment: Inflation Optimism? Split Moods 9-13-24
CPI Aug 2024: Steady Trend Supports Mandate Shift 9-11-24
Facts Matter: China Syndrome on Trade 9-10-24
Tariffs: Questions that Won’t Get Asked by Debate Moderators 9-10-24
August 2024 Payrolls: Slow Burn, Negative Revisions 9-6-24
Construction Spending: A Brief Pause? 9-3-24