I'm back- What have I missed? :-)
Before I left on 1-week Mandatory PTO I put out a Diary piece- Diary Week 39: An Iceberg Looks Great (On The Surface) where I articulated, amongst other things-
"The greatest evil now is not inflation but monetary policy driven by a fear of making the same mistake again. Jay Powell admires possibly the greatest Central banker of all-time, Paul Volcker, who clearly did not operate out of fear. He did what needed to be done.
Everybody remembers that, in terms of the speed and magnitude of rate hikes into May 1981, and the peak of 20%- but few articulate that when the balance shifted he was also very quick to do the right thing and by December 1981 the Fed Funds rate collapsed to 8%
It is time for this Fed to do the right thing ( this week there are signs that the market is starting to see this) and recognise that under their dual mandate they have to start easing. They should be doing this in July but will not ...but who knows, by the time we reach September we might have them in a place similar to Jan 2001 and making a first cut of 50 bp's"
Well, a week later, with the 2-year yield finishing at 4.45% (target on the break of 4.70% was 4.40-4.42%) and now almost 100 bp's inverted to the upper fed funds band that thought appears to be getting traction in markets.
Because of their "misguided" view about forward guidance and their "fear of making the same mistake twice in a row" the bar for July is probably still a bit high for them. (It should not be)
It should be clear, even to a blind man, that policy is too tight, inflation is no longer a "clear and present danger" and the economy and employment are deteriorating sharply. Instead, they are trying to hold the line in a similar fashion to how they did in 2000 (Not moving until Jan 2001)
By then they were so far behind the curve that the first 5 cuts were 50 bp's each and had happened by May that year. They will not wait that long this time, but with the September meeting so far away (almost 10 weeks) there is an increasing danger that the market will price in a higher probability that the first move is in fact 50 bp's.
In that respect I think that the chart of Fed Funds minus the 2-year yield could be instrumental. The history of the last 40 years+ shows that levels in excess of minus 100 bp's in this spread starts to ring alarm bells.
In 2000-2001 that number ended up being minus 163 bp's in Jan 2001 leading to those 5 cuts of 50 bp's over 5 months (In 1989 the number was minus 140 bp's before they cut and in Sept 2007 it was also minus 140 bp's before the first cut.
If this number gets into that range (2-year yield between 4.1% and 3.9%) before the September meeting, then the likelihood of a 50 bp's cut becomes very high indeed.
The Fed is already late to the game and the damage has begun. The longer they now wait the greater that damage becomes.