In the 36 hours since the November FOMC meeting, stocks are down -3.5% and bond yields are up with 10-year up 8bp to 4.13%. But these moves in prices do not reflect a far gloomier surge in investor sentiment.
- The official FOMC statement made a “dovish” modification noting the committee will take into account “cumulative tightening” and “lag” and “economic and financial developments”
- But Powell in the press conference spoke far more hawkishly and noted several times “it’s premature to discuss pausing and it’s not something we are thinking about.”
- As the chart below makes clear, equities fell and bond yields rose
- Investors reacted bearishly and as our Head of Technical Strategy, Mark Newton, noted the equity put/call ratio surged to 1.14, the highest since March 2020
- Fed funds futures rose and June 2023 target rate is now 5.15%, up from 5.02% pre-FOMC decision.
In 2022, it turns out that equity markets see sharp reactions to on FOMC day. And as this tweet by @carlquintanilla shows, it is all about the press conference.
DOVISH + HAWKISH: Powell stated no progress on labor, nor inflation, nor housing = hawk
FOMC Chair Powell was hawkish in his responses during the press conference but was counter to the more measured and arguably “dovish” FOMC statement.
- The hawkish tone of Powell surprised Fed watchers because into the Nov blackout, even 3 of the most hawkish Fed members spoke of a December pause
- The hawkish tone of Powell was also directly countered the dovish official statement
- Powell, in press conference, on labor “I don’t see the case for real softening just yet.”
- Powell, in press conference, on inflation “we haven’t seen inflation coming down.”
- Powell, in press conference, on housing “there’s still some significant increases coming”
- In my opinion, this is the “hawk” worldview. That as long as these 3 items are viewed this way by Powell and Fed, then, they need to be hawkish
- Several media reports reference Powell’s concern that he wants to be viewed as Volcker (“inflation killer”) and not Arthur Burns (“failed”)
DOVISH
HAWKISH
Incoming data argues for more two-sided views and argues dovish pivot coming
But while the “hard data” may not support a softening in the 3 areas noted by Powell, this is not necessarily how these things will look in a few months:
- inflation arguments have become more two-sided recently, measured by PMIs (which show declining price pressures), commodity prices, leading indicators etc
- Other central banks have made “dovish” shifts including ECB, BoE, Norway CB, Bank of Canada, RBA, among others.
- Powell noted there has been little progress on those 3 fronts: labor, inflation and housing
- But leading indicators and alternative data argue otherwise
- We think this is just a matter of time before the data syncs up
- And this will enable Fed to justify its “pause”
- But we see this as highly probable
EMPLOYMENT: Powell said “I don’t see the case for real softening just yet”
His statement is below. But this view could easily change in coming months.
Take employment. Look at the recent ISM manufacturing and services employment figures. A level below 50 is “contractionary”:
- ISM services is 49.1
- ISM manufacturing is at 50.0
- Neither points to a strong labor market
- Many companies have announced major layoffs
- Small biz may continue to be hiring
- But you get the point
INFLATION: Powell “we haven’t seen inflation coming down” but leading indicators argue otherwise
Similarly, Powell said inflation hasn’t come down yet:
- supply side hasn’t resolved itself
- FOMC noted war and related events are “creating additional upward pressure on inflation”
- as we noted in prior reports, we see reasons for services and core CPI to weaken in coming months (more on this prior to Oct CPI report)
HOUSING: Fed is aware that OER lags, but at some future point could look at falling rents
In discussing housing, Powell noted that:
- they are aware of lags in CPI on housing costs
- but deemed this impact “pro-cyclical” implying it makes moves higher and lower amplified
- but this also counters the notion of what the Fed needs to do since the policy rate is designed to fight future inflation, not current
- and he made clear that “at the measure do look at…at some point you’ll see rents coming down”
- in other words, at some point, the Fed will also see leading indicators as more relevant than “hard data”
BOTTOM LINE: Fed might sound hawkish but roadmap to dovish “pause” remains the same
Markets sold off hard post-FOMC. And this was obviously a setback. But as we note above, the factors behind Powell’s “hawkish” views are clear. He wants to see progress on jobs, inflation and housing. And as we have noted, we expect these improvements in coming months.
- thus, we see a roadmap for a dovish “pause”
- investors got even more “bearish” as evidenced by the surge in Put/Call to 1.14, the highest since March 2020 as highlighted by Mark Newton, Head of Technical Strategy
- key events ahead
- 11/4 8:30am ET: October jobs report +195k Street and +263k last month
- 11/10 8:30am ET: October Headline CPI +0.7% MoM Street and +0.4% last month
- 11/10 8:30am ET: October Core CPI +0.5% MoM Street and +0.6% last month
- For reasons we have been writing about over past few weeks, odds favor October CPI to be softer than consensus
- We think risk/reward for equities is far better than consensus sees. And while equities have been under pressure, we think reaction to Fed is an over-reaction.
REAL EQUITY RETURN, NOT NOMINAL: Lastly, Fed should stop “flinching” at rising stock prices
During the FOMC press conference, Powell visibly flinched when asked the below question:
- he was uncomfortable with markets reacting positively
Equities are a nominal asset. With the S&P 500 at 3,800, it is down 25% in inflation-adjusted, or “real terms” YTD. This is simply calculated by taking S&P 500 index and dividing by CPI:
- equities are a nominal asset
- but real returns are the factor behind financial conditions
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