Hi Everyone 👋,

Heading into last week’s FOMC, a pause was nearly certain and highly telegraphed.

But remember, when it comes to the market we have to ask - what is the net new information?

Powell came out of the presser firing in what can be described as a “Hawkish Pause”. Yes - there was no change in the Fed rate, but the tone around the meeting had “higher for longer” written all over it, especially in the new dot plot.

This sent risk-assets tumbling, bringing into question the torrent YTD rally in tech stocks.

While inflation numbers are trending in the right direction, it seems like the boogeyman is still lurking in the shadows.

Since the Fed is the conductor in the orchestra of the US economy, we have to pay attention to how it controls the tempo.

• Heading Into the Meeting 👉 CPI, PCE, Jobs, Expectations

• Release + Reaction 👉 Strikethrough, SEP, Market vs. Dot plot

• Presser 👉 Powell on the Soapbox

1. Heading Into the Meeting 👉 CPI, PCE, Jobs, Expectations

Heading into the meeting, headline CPI was trending in the right direction (down), but we had a recent uptick as of the most recent reading. The main question to answer: Will we resume the downward trend, or are we going to see a plateau?

The CPI figure came in a bitter hotter than expected. Headline CPI rose +0.63% in August, putting the YoY headline gain at +3.7% (vs. expectations of 3.6%). The core CPI advanced +0.3%, which translates into a +4.3% YoY gain.

Powell’s favourite indicator of inflation, PCE also drew the same questions. The headline and core PCE indexes reaccelerated to 3.3% YoY (from 3%) and 4.2% (from 4.1%), respectively, in July.

The other side of the mandate is jobs. NFPs came in higher than expected, wage growth slowed and the unemployment rate surprised to the upside. July’s NFP number was also revised lower.

So we have a labour market that still looks resilient although we’re finally seeing some slowdown and inflation that might look like its plateauing rather than continuing its deceleration.

All this baked together led the market to price a less than 1% chance of a hike at this meeting, but remember, it’s all about changing expectations for the rest of the year.

2. Release + Reaction 👉 Strikethrough, SEP, Market vs. Dot plot

As soon as the statement is released, algos start to jump on the strikethrough to see how any change in language will affect the market:

We had economic activity upgraded from “moderate” to solid, job gains downgraded from “robust” to “slowed”, but “remaining strong”, and of course the “raise” replaced with “maintain” on the rate.

The key point of “net new information” over this release was the new Sumary of Economic Projections (SEP) or the “dot plot”. This data is updated quarterly instead of at every FOMC meeting, and we got an update last week.

Investors were closely watching the dots to see if the remaining hike projected in 2023 would be removed and what the picture looks like for next year. The line you’re looking for on these two charts is the green one.

Prior dot plot:

New dot plot:

The Fed told the market that not only is the planned hike for 2023 is still on, the cuts anticipated in 2024 will be far fewer than before. Higher for longer.

Another graph that I always look at before and after the meeting is where the market believes rates are going. There is a good representation in the graph above if you look at the purple line.

Digging in a bit deeper, you can check the exact probabilities that the market is pricing in. Here is the chart before the meeting, on Tuesday:

And after the meeting, on Thursday:

If you look further out to the end of 2024, expectations did not materially change. So while the Fed is saying “Higher for longer”, the market is still saying they don’t believe the Fed. You can also see this in the divergence between the purple and green lines in the new dot plot.

3. Presser 👉 Powell on the Soapbox

The statement never really says much so we need to listen to Powell’s presser to try to temperature check the Fed.

In the presser, Chair Powell said the FOMC was in a position to “position to proceed carefully” in deciding if further restrictive action(s) was necessary.

Powell hinted that a higher-for-longer approach was warranted because estimates of the neutral interest rate could be higher than thought at least in the shorter term. The neutral interest rate is a level that neither speeds up nor slows down growth.

Here are some key quotes from the presser:

“It's a good thing that the economy is strong. It's a good thing that the economy has been able to hold up under the tightening that we've done. It's a good thing that the labor market is strong. The only concern is it just means that if the economy comes in stronger than expected, that just means we will have to do more in terms of monetary policy to get back to 2%.”

“The proposal at the meeting was to maintain our current policy stance and I think there was obviously unanimous support for that. But this is an SEP meeting and so people write down what they think and you've got seven who wrote down “no hike” between now and the end of the year, and 12 who wrote down another single hike in one of the next two meetings that we have between the end of the year.”

“The risk of over tightening and the risk of under tightening then becomes more equal. 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 that's what we're doing.”

Wrapping Up…

Another thing I like to look for in the market is professionals who are making non-consensus calls. Chief Economist Jan Hatzius at Goldman Sachs is one of them. He has been against the grain, consistently lowering his odds of recession when a recession was a foregone conclusion at the start of the year.

Hatzius thinks the Fed is done hiking. He believes, “The inflation data is going to surprise them [the Fed] in a favourable direction, and I also think that fourth-quarter growth is likely to look quite a bit weaker than the third quarter.”

What do you think? Is the Fed done hiking?

Until next time. Always Yours. Incessantly Chasing ROI.

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