This Fed FOMC meeting is interesting, as always, the real “devil” is hidden in the details, let’s take a look at some of the most interesting nuances and market implications.
Original: Alf Twitter
This Fed FOMC meeting is interesting. As always, the real “devil” is hidden in the details, let’s take a look at some of the most interesting nuances and market implications.
“Trust me, we’re tightening enough to bring inflation down to 2%,” was Powell’s words at the end of his news conference, with a strong message reflected in the updated dot plot.
Interestingly, 12/19 FOMC participants expect the federal funds rate to be between 4.50 – 5.00% by December 2023. Despite the poor predictive power of the dot chart, its signalling effect is clear – the Fed is ready to keep a tightening environment in place for a long time.
So does the market (blue) pay for such aggressive dot plots (orange)?
The answer is, so-so. The OIS market is pricing in a similar terminal rate of 4.6%, but it’s really hard to believe that the Fed can keep rates above 4% for 2 years.
Data > Dot Plot.
Powell referred to the late 1970s several times at the meeting: Easing monetary policy prematurely while battling inflation could have adverse consequences.
The core PCE basically did not show a plummeting trend, let alone the suspension of tightening policy, “We will stick to it until the work is completed.”
Powell’s reference to “necessities” inflation also appears to be relevant, as if as long as it exists, low-income earners will take advantage of the still tight labor market to demand further increases in their own wages.
After all, low-income earners represent an important group when it comes to consumer spending.
All in all, it’s another reiteration of the Jackson Hole speech: The Fed will hold on until the job is done, and they understand that pain is necessary to bring inflation down.
However, if the CPI cannot be lowered, more costs will be incurred in the future. In other words, the Fed is not reversing.
Before we turn to market impact, I find it interesting that Powell is not thinking about peddling mortgage securities at all. Low-probability, high-impact event: It would “help” the Fed to further weaken the housing market, but it could also cause surprises in the market. So leave it out for now.
Turning to the market, let’s look at bonds first.
Real yields are largely unchanged, but Powell will be happy to note that the entire real yield curve (orange) is well above 0% today – there are conditions for the tightening to continue for longer. And this was not the case 3 months ago (yellow).
High real yields in the bond market are not necessarily positive for risky assets. But if real growth is also slowing, they become one – which is exactly what is happening now.
The harder the Fed tightens, the greater the long-term damage to future growth. The clearest expression is the slope of the yield curve, which has again started to flatten sharply.
The U.S. 2s10s OIS curve is trading at minus 90 basis points, and the more aggressive the Fed’s policy, the more it reverses.
We’re at a very interesting time for long-term bonds, because now additional front-end tightening could lead to lower long-term bond yields, as we’re seeing today.
Damage to long-term nominal growth may be a more relevant driver for 30-year bonds than front-end interest rate levels.
Overall, when it comes to risk assets, the picture is simple: If they rise, financial conditions ease, and the Fed doesn’t like that.
Also, we can simply plot a 5-year bond real interest rate (orange) versus SPX (blue, inverted), do you see this clear gap?
Even without lowering returns or assuming a larger risk premium, risk assets don’t seem like a great investment opportunity here.
My base case is that SPX will retest the 2022 lows.
What about precious metals?
While the hoarded form of dollar cash nominally pays a real interest rate above 4%, it can also be a positive real interest rate, and alternative and interest-free forms of the currency tend to be downgraded. That is, bad for gold.
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Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/reviewing-the-september-rate-hike-meeting-what-other-important-signals-did-the-fed-reveal-after-the-third-violent-rate-hike/
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