Don't Rock the Boat
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Powell’s press conference was SO boring.
Which means he was doing exactly what he needed to do.
But then Yellen picked up the mic and went, “hold my beer”.
In what was one of the most widely anticipated Fed meetings in recent memory, the Fed really had its job cut out for it. They are up against: inflation finally starting to come down (but still sticky in areas), a strong labour market, and a banking crisis causing systemic risk sprinkled on top.
Even though they delivered the widely expected 25bps hike, and the “wait and see” approach, the market flip-flopped around contradictory comments from Yellen.
In light of the recent banking crisis, one of the most important things to do right now is not to panic - and while Powell came off as the king of cool, Yellen threw some mayhem in there because - why not - it’s 2023.
I’ve always believed that one of the best principles in the market is to have “high convictions loosely held”. This means you do your work and are sure of it, but are willing to change, adapt, and adjust according to new information received. Act always on first principles. Ultimately, I do believe Powell achieved this.
Now, you could say that he was slow and far too reactive rather than proactive when it came to calling inflation transitory. But when there is a systemic risk as there has been in the banking sector, level-headed patience, deep due diligence, and the willingness to solve the problem at its root are all critical to finding a long-term solution.
Enough prose - let’s get to the FOMC.
This week, in <5 minutes, we’ll cover the FOMC:
Heading Into The Meeting 👉 Banking Crisis Already Caused Tightening
The Redline 👉 Old Statement vs. New One
The Presser 👉 Powell’s Q&A: “We don’t know”
The DOTS 👉 Tell Us Nothing - All Over the Place
Let’s get started!
1. Heading Into The Meeting 👉 Banking Crisis Already Caused Tightening
An argument for the “pause” crowd going into the meeting was that the onset of a banking crisis already effectively tightened financial conditions and that this has done Powell’s job for him - so don’t hike.
A common indicator used to assess financial conditions is the Bloomberg United States Financial Conditions Index.
The Bloomberg U.S. Financial Conditions Index tracks the overall level of financial stress in the U.S. money, bond, and equity markets to help assess the availability and cost of credit. A positive value indicates accommodative financial conditions, while a negative value indicates tighter financial conditions relative to pre-crisis norms.
We had a steep drop at the onset of the banking crisis, which has now effectively bounced back, regaining half of the falloff.
The concern here is around a slowdown in economic activity. A critical component of the lending environment, regional banks, will come out of this heavily hampered. They’ll make it out, but the post-op will come back with results that will cause tighter regulation, slow loan origination, and increasing reserve ratios which will ultimately slow economic activity.
When the cost of borrowing goes up people do less business. It’s as simple as that. This banking crisis did some serious damage.
So let’s see how it was addressed in the meeting.
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2. The Redline 👉 Old Statement vs. New One
This month, we had quite a few changes to the opening remarks. Here is a strikethrough of the new statement vs. the old one:
So the key language in this redline that everyone was pointing to was crossing out “ongoing increases” and putting in “some additional policy firming MAY” be appropriate.
Those in the “pause” camp can chalk up that phrasing as a win.
Another critical point was a shift in focus toward the current banking crisis. The redline acknowledged that tighter conditions are going to weigh on the end consumer, even explaining that this too will have an impact on inflation. Now onto the presser where Powell elaborated.
3. The Presser 👉 Powell’s Q&A: “We don’t know”
The statement is always just read by algos in tandem with the decision, and the market does its first leg move on the trading day over FOMC. The next moves always come from the presser, and this was an important one.
Powell elaborated on the acknowledgment that the worsening bank crisis could effectively be doing the Fed’s job for it, but is taking a “wait and see” approach.
It's possible that this [banking crisis] will turn out to have very modest effects - these events will turn out to be very modest effects on the economy, in which case - and inflation will continue to be strong, in which case, you know, the path will look - might look different. It's also possible that this potential tightening will contribute to significant tightening in credit conditions over time, and in principle, if that - that means that monetary policy may have less work to do. We simply don't know."
When it came to insuring the public that the bank situation is under control, Powell said that they, “have tools to protect depositors, prepared to use them.”
However, it seems that Powell didn’t know what Secretary Yellen was saying at the same time. In a weird way to run things, Yellen also had a press conference at about the same time where she said that she is “not considering a broad increase in deposit insurance.”
You’d think with something THIS important, that they would 1) align their messaging; and 2) provide specific examples of the exact tools available to use. With ambiguous messaging, the market gyrated accordingly.
During the presser, Powell also reiterated that cuts were not in his plans. However, the market doesn’t really believe him:
Instead, the market is pricing in a series of cuts all the way back down to ~4.2% by the end of the year. Does this mean the market is expecting a recessionary scenario where the Fed will finally be forced to cut rates?
Bonus: My personal favourite quote from the presser:
“I’m not saying anything more than I’m saying. So what I’m saying is you’ve seen that we have the tools to protect depositors when there’s a threat of serious harm to the economy,”
Try that line that I bolded there on a first date when you think they’re trying to read too much into a certain situation…
A masterclass at speaking without saying anything.
4. The DOTS 👉 Don’t Read Too Much Into It
Now time for some voodoo: the dot plot. In times when you have a consistent battle with a known enemy (inflation), these are very important.
In times where uncertainty is high when fighting the systemic risk of bank failure, these dots are definitely less telling. The Fed will remain flexible in its approach as the data changes. Let’s take a look at how the projections shifted.
Back at the end of last year, we had the expected terminal rates for
2023: 5.125%
2024: 4.125%
2025 3.125%
Now, we have:
2023: 5.125%
2024: 4.25%
2025 3.125%
So we didn’t really have that material of a change between the meetings when it comes to the median forecast. What we did have, was a little bit more dispersion when it comes to the 2023 end-of-year number.
Either way, the dots tell us one more hike before the end of the year.
Wrapping Up…
The overall message is one of continued focus on inflation but also a willingness to be flexible in response to the ongoing banking crisis.
This is a Fed caught in the middle of several crosscurrents (many of which were their own doing). There is a ton of uncertainty, and it looks like they could be pausing because – like a lot of us right now – they feel stuck.
They’re also saying they don’t see rate cuts this year…but time will tell if that belief will also prove…transitory.
Until next time. Always Yours. Incessantly Chasing ROI,
-Genevieve Roch-Decter, CFA
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