FOMC: Hit Squad or Suicide Squad
We take a quick look at what's being called a "hawkish pause" after the prior "dovish hike."
"FOMC Economy Squad opts for a pause, but stands at the ready..."
The market was not ready for a pat-on-the-head pause at the same time as a speed skate kick-in-the-eye on the hawkish outlook.
The reaction was immediately negative, but the S&P 500 and NASDAQ still finished in the green.
The reality is that any fed funds hike is still data-dependent, the comps are getting better in many slices of the inflation picture, and some will treat this is a posturing action to send signals to the market to take them seriously.
The handicapping immediately started on whether this was a credibility building action to shape inflation expectations downward and perhaps scare down some jobs openings and headcount planning.
The FOMC process was starting to seem dull, but the dot plot from hell today was shutting down those looking for easing in 2023. There was also a 100 Hi-Lo bps range on the fed funds for year end 2023 that ranged from 5.1% to 6.1%. The midpoint range on the dot plot had 9 of the 18 between 5.5% and 5.75% with only two between 5.0% to 5.25% (i.e., the status quo). We see 4 in the 5.25 to 5.5% lane (one hike). The number of plots below 5.0% was a cool zero. Two were above 5.75% and one above 6.0%. The opinions on inflation are clear in that mix. They are in hawk mode.
We see real GDP forecasts from the FOMC for 2023 as gloomy in the release with the median at 1.0% (but up from 0.4% in March). The unemployment median was around 4.1%, down from the March projection of 4.5%. There was a time when 4.1% was well below full employment and would set off NAIRU warnings and wave red flags at the FOMC.
That inflation drivers of the past and in today’s politicized trash talking does not help the cause-and-effect assessment. The weighting of what used to drive inflation was before the COVID disruptions and stimulus waves that came after. In the political concept lite game in Washington, there is a tendency to ignore the supplier chain disaster of COVID and how that stacked up against demand and job stimulus. We don’t expect that to change any time soon. Supplier chain improvement and calendar year comps are helping bring down CPI (see May CPI: The Big 5 Buckets and Add-Ons 6-13-23) but tight labor is keeping wages higher and PCE demand strong.
Framing inflation trends and trying to guess where the Fed will swing just got harder. In the CPI, you can look at a CPI for All-Items Less Shelter metric of 2.1%, Core CPI at 5.3% and then look at Services at 6.3% (Services less Rent of Shelter at 4.2%). That cannot be anything other than a challenge, so the Fed picks jobs as the focal point it appears.
We are of the view that the Shelter metric used by the BLS right now is functionally useless and essentially the Owner Equivalent Rent metric – as the #1 weighted variable in the CPI index at over 25% – as simply invalid as an inflation metric at this point. Meanwhile, the lagging BLS rental numbers in CPI weigh in at 7.5% of the index. The favored PCE inflation number the Fed prefers is not as easily dismissed as CPI Shelter, so that one keeps the Fed on edge (see Personal Income and PCE: Inflation Stickier 5-26-23). The fact that the rental CPI number is 8.1% is just wrong (for good reasons, but still wrong).
The theory is that the hawkish pause could promote some defensiveness perhaps in inflation expectations or JOLTs levels, but the more tangible sea level risk could be the spooking of regional bank earnings trends ahead on more beaten down interest margin squeeze.
We will revisit the lookback analysis across the years at the fed funds relationships with credit markets and spreads. We looked at those a lot in the fall but will dust those off. The pace of this round of moves in 2022 and into 2023 is worse than the absolute levels in historical context, but the post-ZIRP world does not want to hear about the history that 5% fed funds can coexist with bullish risk markets. It has been lumped under “too much too soon” for many investors.