While market commentators seem convinced The Fed will hike rates today, the market is less convinced – assigning a two-thirds chance to it, the lowest for an FOMC Day in years.
The bigger question is just how ‘dovish’-ly can Powell hike? And, more importantly for world harmony, can he avoid the appearance of kow-towing to the President (because god forbid, establishment elitists would be forced to agree with the current White House resident’s views).
His dovishness bar is set extremely high already, as former fund manager and FX trader Richard Breslow notes, the shift in forecasts as to what the FOMC might do later today has been changing day by day. With every downdraft in equity prices the degree to which the Fed is expected to infuse its decision with dovishness has increased.
We have even managed to convince ourselves that the stock market knows best. And in an investing world that has become long-only, it is easy to understand why people would think that way.
At the end of the third quarter, when stocks were making new highs, the interpretation of economic data tended to err on seeing the brighter side whenever a number missed or was ambiguous in its message. After this sell-off, that has clearly reversed. We see recessions lurking behind every turn of the calendar.
Suddenly, the various financial-conditions indexes have become the most widely discussed economic data points. It had to because while some numbers have been squishy, you can’t justify the extent of this change in sentiment by the “slowdown” in economic growth and employment that has been posted.
The base case for today’s outcome has become a dovish hike with an optimistic spin. Something for everyone. That’s not easy to deliver. Especially with the burden of those dot plots they continue to carry around, try to de-emphasize and which are universally fixated upon. You can’t really be convincingly data-dependent when you have to justify everything around a meaningless exercise.
It is not a coincidence that the highest price of the year in S&P 500 futures occurred on the same day as the high in WTI crude. And at the time, while investors were willing to acknowledge that equities might have some of the characteristics of a bubble, was anyone calling for the collapse in oil prices?
Back then oil futures were still in backwardation. And, for lack of a better thing, most central banks go right to the futures curve for their forecasts. Pity the traders who think they are gospel truths.
Be especially leery of predictions about how various markets will trade based upon what we will hear. Especially a week before the end of the year. The 2s10s yield spread has widened a bit since the beginning of the month and investment-grade credit spreads have stabilized. Both in anticipation of a more accommodating Fed. But so far, people have continued to look for any excuse to reduce exposure to high-yield. And it is surprising how non-existent the bounce has been in equities if people really think this will be a game- changer.
Given how far these markets have moved, they can have sizable corrections within the context of larger trends. But you can be sure whatever happens will be assumed to define the way forward.
At the end of the day, an extra 25 basis points either way will make little difference to the economy. Especially since so many of the prevailing “headwinds” have nothing to do with U.S. monetary policy.
But, as Breslow notes, the FOMC will face two big challenges with ongoing significance. Chairman Jerome Powell will need to be sufficiently even-handed so as to not have investors conclude that this is the end of the tightening cycle, yet market- friendly enough to avoid the inevitable and ridiculous taper tantrum. And the much greater challenge of convincing anyone a dovish lurch isn’t just where the new Fed put is struck and the party can begin again.
Especially as “dovish hike” mentions on Twitter are taking off
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