“For Powell The First Cut Was Always Easy; Now Comes The Much Harder Part…”

By Michael Every of Rabobank

As a central banker, you’ve failed to communicate when you prompt our Fed watcher, Philip Marey, to quote Orwell back at you. After the FOMC cut 50bps to 5.00%, as only in past crises, yet Fed Chair Powell said he wasn’t behind the curve, just “recalibrating”, and the US economy is “good”, Philip’s retort was:

“Really? A 50bps cut as a message that the economy is strong? So, if they cut by 75bps the economy is booming? This sounds like something out of George Orwell’s 1984: WAR IS PEACE; FREEDOM IS SLAVERY; IGNORANCE IS STRENGTH.”

The most benign interpretation is Philip’s view of “stag” not “flation” as the guide. Even so, going 50bps when the economy is strong — housing starts and building permits both leaped pre-Fed– may be wasting valuable ammunition: would a sudden deterioration mean a 75bps cut?

Alongside that “grifty, shifty, not nifty” 50 were revised forecasts. Unemployment at 4.2% is expected to rise to 4.4% in Q4 and 2025 before going back to 4.2% again: optimistic? Inflation for 2024 and 2025 was revised down, and in 2026 will be at 2.0%, as also seen in June: optimistic? GDP growth for 2024 was revised downward very slightly to 2%, but out to 2027 was unchanged: optimistic?

Yet we got big changes in the dot plot. End-2024 Fed Funds dropped from 5.1% to 4.4%, meaning 25bps cuts in November and December, so sing ‘The First Cut is the Steepest’; 100bps of cuts are seen in 2025; and 50bps in 2026. That means the long-run floor for Fed Funds is 3%. Indeed, Powell’s Q&A stressed the neutral Fed Funds rate was probably higher now than in the past, and he wasn’t expecting to return to New Normal lows.

If cutting 50bps and saying all is well was problematic for Fed credibility, so are its happy projections for markets that have already priced a lot of ‘BAD IS GOOD’ news in. 10-year yields dropped on the Fed decision then rebounded as Powell spoke, and at time of writing were 11bps off their initial post-cut low at 3.73%. The dollar slumped, then retraced losses.

A less benign interpretation for 50bps is politics. “In central banking? What next: politics in economics?!” However, Philip adds Powell had incentive to deliver a big pre-election cut because Trump won’t reappoint him as Fed Chair and may remove him prematurely; his only chance of another term is to please Harris. Yet a 50bps cut “is taunting former and possibly next President Trump. This could have serious repercussions next year. The sole dissenter, Michelle Bowman, may just have improved her chance of becoming the next Fed Chair.” Underlining that dynamic, there was post-cut praise from one Democrat for “following the data” (like we “followed the science”); and criticism from Republicans and Trump, who stated, “The economy would be very bad, or they’re playing politics, one or the other, but it was a big cut.” Things could change bigly for the economy, inflation, and the Fed come November, then 2025.

As warm-up, and following the acerbic tweet that “The Fed is expected to cut credit card interest rates today from 20.78% to 20.28%”, Trump, after what initially looked like a bomb threat, and declaring his policies at campaign events, is now promising to temporarily cap credit card interest rates at 10%. How would this work? No details. Could it happen? No idea. Would it raise US demand far more than the Fed rate cut? No denying it – and bigly. But, hey, let’s talk more about the Fed and that 50bps and what it means for asset prices.

“WALL STREET IS MAIN STREET”

Getting far fewer headlines, Brazil raised its Selic rate 25bps after the Fed cut, moving from 10.50% to 10.75% as expected, and signalling more hikes to come due to upside inflation risks. Does that make Brazil a global outlier or a thought leader? Only time will tell, but for the Fed getting to a first cut was always the easy part, even if they have messed it up. The harder part was always going to be ensuring they don’t get a 1970’s style rebound in inflation once “RATE CUTS!” start to flow into asset prices, commodities, and still-hot services. Our US election base case already assumes this happens via tariffs; other things threaten similarly.

As I concluded yesterday: “back to waiting for the Fed. Or the next geopolitical bang.” Within hours, walkie-talkies, radios, phones, and solar heating systems started exploding across Lebanon and Syria in what is almost certainly a follow-up attack by Israel after yesterday’s “Paging Mr. Terrorist” episode. Reportedly, it was use-it-or-lose-it for Israel as the plot was close to being discovered. The tactical imperative would be a major military follow-up vs. Hezbollah, which the Israeli war cabinet has approved even at the risk of triggering full-blown war. Hezbollah leader Nasrallah is expected to speak today; his recent speeches have tried to deescalate, but will this one?

Of course, the Fed isn’t considering the Middle East at all; nor what I wrote yesterday about the economic implications of the exploding pager incident: national-security bifurcation of supply chains, implying potential moves with dot plot impact within the dot plot’s forecast timeframe.

However, the White House is considering the region too much given the State Department just refused to redesignate the Houthis attacking Red Sea shipping as terrorists, as this would be unfair on ordinary Yemenis (whom the Houthis shoot, starve, and enslave). Perhaps “terrorist” is not the correct definition – it should technically be “pirate”; but even there the US has past form for swashbuckling, not buckling. Today, critics point out a US inverse Vegetius –“If you want war, prepare for peace”– won’t re-open Suez or present a united front against Iran. Others point out that Tehran attempted to pass hacked Trump campaign info to the then Biden campaign: so that’s where they got “no tax on tips” from?

Ukraine attacked a huge Russian ammo depot in Toropets, which didn’t get the same media headlines, but underlines how rapidly output from military-industrial supply chains disappears.

As mentioned here, the CEO of Flexport notes: “The biggest wild card in the presidential election that nobody’s talking about? The looming port strike that could shut down all East and Gulf Coast ports just 36 days before the election.” That wild card also applies to the Fed.

If the International Longshoremen’s Association representing 45,000 dockworkers strikes for the first time since 1977, US businesses could miss the key Black Friday/Cyber Monday peak sales period. Port trade is around $2.12trn, and 72% would grind to a halt, a one-day strike reportedly taking six days to recover from, a one-week strike in October creating bottlenecks until mid-November, not factoring in Red Sea disruptions caused by the not-terrorist Houthis. If goods then shift to the US West Coast ports ‘In Deep Ship’ during Covid, the claim is Asia-US freight rates could leap to $20,000, far above the peak seen in the last supply-chain crisis. That would mean firms with low margins might opt not to import at all, creating empty shelves.

While the Taft-Hartley Act gives the president the power to impose an 80-day cooling off period to delay a strike, Biden has said he doesn’t intend to use it here given the impact doing so could have on union votes; that as the Teamsters refused to endorse a presidential candidate despite its traditional Democrat support, as the majority of its members polled back Trump. On the other hand, the kind of strike described above would hardly help Harris come 5 November. So, what’s it to be?

“VOLATILITY IS STABILITY”

“Orwell, at least we got a 50bps cut.”