So, I went into yesterday's Fed meeting with a number of views.
I was totally convinced that the Fed would deliver a "hawkish ease" mainly because while they did not want to cut, they had not seen enough in the employment and inflation data which many speakers had flagged as important for this meeting to allow them to pause. They should have paused, but were clearly fearful that a pause would look political at this point.
I also believed that the path of Equities would be higher into the Fed meeting but then you should hit the "sidelines" as the danger was that Jay would deliver a 2018'esque hawkish message. For those who do not remember that time- from the morning of the Fed meeting on the 19th December 2018 into Christmas eve the S&P fell over 9%.
As a consequence of both the views above I actually thought that on the day that TY1 might actually rally as a move to a pause guidance and a fall in Equities would possibly feed positively in Bonds in the short-term.
How wrong I was
What the Fed delivered was way above my "chart of expectations"
What they did was (In my view) firstly set the store to do what they wanted to do.
What I mean by that is the Fed always decides what it wants to do and then "creates" the justification for the move. The Fed wanted to pause but did not feel it could- that is so clear (and so wrong).
If pausing was the right move then just do it. They thought a 50bp's ease was the right move in September (on the back of the employment picture) and just delivered it.
In an attempt not to look political they reacted to the political reality and therefore by definition became politically influenced.
So, they set the playing field by raising by 4/10ths the Core PCE expectations for 2025 while trying to argue that that level was still lower than today. That (in their minds) made it ok to make yesterday's cut.
On the basis of that inflation forecast change (the validation) they then increased the dot expectation by 50 bp's in both 2025 and 2026. Let's think about that for a moment. At the last minute in September, they decided to cut 50 and in November they cut 25 and told us that the Employment/inflation dynamic was balanced and under control with their 2% target for inflation very much in play.
Then in December they cut 25.bp's. They have one dissent (and apparently 3 absents ) on the dots. They raise the inflation forecast by 4/10ths and raise the dots by 50 bp's out to 2 years.
They have zig zagged about where they stand over 4 months and then follow it by wanting us to believe they have figured out what all this means for the next 2 years. You really have to be kidding me
That just defies credibility and unfortunately from my perspective is what at least for now totally blew up my short-term rally view- Mea Culpa.
Now the market and the Fed are on totally the same page for 2025 in thinking 2 cuts.
I said yesterday (and it was not tongue in cheek) that we can therefore confidently believe that 50 bp's of cuts next year is the one outcome that will not take place.
What does this mean for markets now?
Firstly, because of the "scars" of 2021-2022 Jay will not easily capitulate like he did in 2019 (in fact to a certain extent as soon as a week after the Fed meeting back then he started capitulating and the Equity market instantly bottomed out). They are worried about inflation again and the one thing they are afraid of more than anything is making the same mistake twice in a row. Rather make a different mistake than that.
As the Equity market digests this, I think there is a danger that the overnight bounce is short-lived and if it falls again. If so, it may temper the bond market fall for now. If we were to get a 2018 'esque move I think a rally in the bond market short-term could materialise. Back in 2018 we did not really see that bounce materialise until the equity market posted that larger 9% fall.
However, I have been banging the drum about how pivotal the 109 area is on TY1 and IF we get a weekly close below there then further material losses look likely. That would give us a close above the 4.49-4.50% area on the yield chart and open up further topside.
To where?
First stop would be 4.70-4.73% and then above there back to the highs at 5.02%. In the big picture a break of that high would open up the possibility that the move could take us up as high as 5.75% over time. That is something that I suspect the Equity market, and the economy would not like.
A January pause has to now be considered the base case which means that there is likely limited scope for the 2-year yield to move materially in either direction from here as it likely continually gravitates to the mid-point of the fed funds rate at 4.375%.
4.36% was the high yesterday.
To go materially higher than that would need the market to start thinking that the next move could be a hike. While that is very possible and has a number of historical precedents now is way too early for the market to go there.
As a consequence, the yield curves (2's versus longer end) will likely be driven very much by what the longer end of the curve does. In that respect I am still very focused on the 2's 30's curve with a close over +37 bp's (not yet seen) signaling a move as high as +55 to +60 bp's. Over time the longer-term target there is as high as +125 bp's.
If we are on a sustained pause from the Fed more heavy lifting would likely be needed by the 30-year to see that move.
The USD will likely be a big beneficiary either way as it will either rally on higher US yields and wider spreads or in a risk off environment by lower yields and wider spreads as other central banks are more dovish than the Fed.
A move on the USD-index towards at least 115 and possibly even 120 as noted in The 12 Charts Of Christmas. (Click title for link to piece) looks likely.
There is no reason in this instance to own Gold as higher yields and a stronger USD will push back against inflation and the economy, and I would not be surprised if we see Gold head down much lower- possibly even as ow at $2,075-$2,150.
That is before we even talk about an administration that is going be so pro "Digital Gold" (XBT) for the next 4-years. We may be going into a period where the phrase often used by Gold bears- that in the 21st century it is a "barbarous relic" may be borne out.
Equities now seemed priced for perfection in terms of valuation, lack of breadth (Mag 7) and anticipated Fiscal and regulatory changes.
What can go wrong?
At this point they look potentially susceptible short-term but the more medium-term picture is still a work in progress.
However, I have long been of the view that in the cycle period of 2023-2025 the Fed would ultimately find a way to do what it does best and deliver a policy mistake.
Time will tell but I wonder if yesterday was the first step in that direction for 2025.