Jay Powell delivered the expected (not by the majority obviously) 50 bp's move and by all accounts (speculation) due to his force of will.
He is known to respect Financial and economic history and followed exactly the same path the Fed followed on 18 Sept. 2007 when they also delivered a surprise 50 bp's cut.
Then, however, unbeknown to both the Fed and the Financial markets they were "desperately behind the curve" and only as we went in Q1, 2008 did that become increasingly apparent unleashing a financial tsunami including a75 bp's cut in January after following this 50 bp cut with two 25's in October and December.
While in the Bond market and also the equity market we have followed a path very reminiscent of that period it is premature at this point to suppose that 2025 will be another 2008. It will clearly depend on the backdrop we see and their reactive function.
Speaking of their reactive function it seems like the market this time completely forgot the new view of the World that the Fed delivered in 2019.
In a nutshell they preached that a pre-emptive move provided better insurance against a downturn than "chasing the horse after it had bolted". In particular that served them well in 2019 when they cut rates and even more in 2020 when covid struck. It was not the pre-emptive move that tripped them up but rather overstaying the unprecedented accommodation delivered during covid combined with the perfect storm of the supply chain disruption and to a lesser extent the Russian invasion of Ukraine.
To the Siren voices talking about easing 50 bp's being a mistake when the Equity market is virtually at its peak, I would again direct you to 2007 when it was exactly the same case and after the Fed 50 bp's cut we actually set new all-time highs. In 2000 when they refused to cut at this point in the cycle it ended up with 5 consecutive 50 bp's cuts starting in Jan 2001 after sharp falls in the equity market and a new peak in the cycle for unemployment that month of 4.2%
To those banging the drum about CPI- 2 things
- CPI is not their preferred measure- Core PCE is. While the monthly core CPI did print slightly higher the year on year was unchanged and with 3 out of 4 of the next base effects being 0.3 and the following 3 being 0.4- the base effect is still likely to push that number lower in the months ahead.
- Core PCE is at 2.6%- effectively a cycle low after peaking at 5.6% in Feb 2022 and 4.2% when rates went to 5.5% in July 2023 (14 months ago making it the 2nd longest period of "higher for Wronger" after the 5.25% peak from June 2006 to Sept 2007- 15 months)
Why on earth do people think it was the right thing to keep rates up here and move slowly on the first ease?
Real rates were effectively at 300 bp's and the trend deterioration of Unemployment (0.9%) from 3.4% to 4.3% -Now 4.20%...(or unrounded 4.25% and 4.22%) is much worse than we had at the start of the easing cycles in 1989 (+0.3%); 2001 (+0.4%); 2007 (+0.3%) and 2019 (not even at trend low which was hit 2 months later) and equaled only once going back 50 years in 1974 (July) when the first cut was 375 bp's.
So, we have had the 2nd longest "Higher for Wronger" period in modern history, shorter that 2007 by just 1 month. The equal highest rise in the unemployment rate of .9% (tying 1974) and the first time in 50 years that we have taken real yields higher than the prior cycle (and almost equal to the 2006 cycle) with debt to GDP at over 120%.
There is honestly virtually no argument against this 50 bp move except the belief that with all of the main factors that caused this inflation surge now gone (Covid, the biggest fiscal and monetary stimulus in the history of mankind, a 32% savings rate, Russia invading Ukraine, an Oil price at $130 etc etc) that at this point inflation is still the greatest danger to the dual mandate.
It clearly is not, and nobody can know if that will re-emerge again in the future- but that is for the future. We have to deal with the present and I for one applaud Jay's fortitude.
Going forward we are going to have to realise also that it is about tradeoffs and no arbitrary 2% line in the sand inflation number is worth pursuing at whatever cost.
We will clearly, coming out of this episode see a more pragmatic rather than dogmatic approach to inflation just as there has been to NAIRU with probably an average over time rather than an absolute change in the 2% target being the way the Fed will go.
Will we continue to follow the path in markets and Fed policy responses that e saw in 2007 (two more 25 bp moves by year end)?
That looks the more likely course for now but is likely to be very dependent on the course of the Employment data. If unemployment continues to move higher that is likely the minimum expectation (In 2007 it rose from 4.6% to 4.7% in September but then "Popped to 5% in December. (January print). This led the fed to cut by the two 25 bp increments mentioned above but the December number induced a 75 bp cut on 22 Jan 2008.
For now, looking at all of this as I mentioned above it still seems reasonable to follow the 2007 analog for now and possibly towards year end but future developments in markets, the economy and the fed response are likely to shape how things look going into Q1, 2025.
So, what did we see post the Fed meeting on Sept 18, 2007?
The US 2-year yield did fall on the day but struggled to follow through. By 15 Oct 2007 it actually hit a level that was 23 bp's above the close on 17 Sept, 2007 (the day before the Fed meeting). That would today equate to a move to around 3.83%.
Then the real move lower began and continued through to early December.
The US 10-year yield was also choppy closing up slightly on the day of the Fed meeting and rising 23 basis points in the days thereafter (from the 17-Sept low) into the end of that week. That would equate to a quick move towards 3.80%+ in the coming days.
The US 2's 10's curve steepened sharply from the 18-Sept low through the 26th September (30 bp's- an equivalent move today would see a level close to +28 bp's by the end of the month) and ultimately continued higher all the way into December
The Equity market rallied strongly on the day (This time had a 1-day lag in that respect) and a new all-time high in the S&P was hit on 5th October. We are "ahead of the game" in that respect having hit a new all-time high yesterday. The equity market peaked and turned on 11th October, 2007.
Could the cause and effect of the peak in the Equity market (11 October) and the 2-year yield been the Employment report on 05 Oct? (The 11 October high was not much above the new all-time high hit on 05 Oct)
Unemployment hit a new trend high at 4.7% in Sept 2007. NFP did beat expectations by +10k (110k versus 100k expected) but the prior month was revised lower by -21k. That combination was enough for the Fed to cut rates again on 31 Oct but only by 25 bp's. During this period Core PCE YOY dropped by 1/10th and Core CPI was stable.
From 18th sept 2007 Gold went up pretty much in a straight line until November (about 17%- which would equate this time to around $2,980)
Between the 18th sept 2007 and 23 Nov the USD-Index (DXY) dropped about 6.7% which would equate to around 94.50 this time.
The above moves in markets are not cast in stone this time around by any means but they are a as good a roadmap as any right now (and so far the 2007 roadmap has been the best available unless and until proven otherwise)
So, for now, long curve steepeners (but not outright Fixed income, Long equities, Long Gold (and probably Bitcoin) and short the USD seem the most logical plays as we see what "pans out" in the coming weeks.
However, I cannot stress enough that the key to the path of markets between now and year end will. I think, be firmly driven by what the Employment reports deliver and the Fed's subsequent reaction function. If these factors differ dramatically in the coming months to 2007, then so likely will the market moves.