Does the Fed Know Something We Don't?

Wednesday was one of the most interesting non-rate hike Federal Reserve meetings in a while. The main takeaway is that the Fed is bending over backward to be dovish. It isn't just that that Quantitative Tightening is coming to an end. They took every chance, changed every word, and made every promise they reasonably could to give the impression that rate hikes are over. Here's my take on what's happening. Balance Sheet Contraction Just About Over The Fed specifically said that it is prepared to adjust any of the details for completing balance sheet normalization, which sounds vague enough, but was made even more vague by Fed Chair Jerome Powell's unwillingness to clarify. However, there's no reason to bring this up unless they are mostly done with balance sheet contraction. I would guess by mid-year they are done with QT. Powell also didn't say what the composition of the balance sheet would be going forward, but I expect it to be mostly Treasury bonds. Long-term that will weigh on mortgage bond spreads, but I don't expect it to have any meaningful short-term implications. Is This Just a Pause or the End of Tightening? I have written several times that an extended pause was unlikely. Either job growth would continue and eventually the Fed would be forced to start hiking again or growth would turn weaker and the Fed would start cutting before long. Powell doesn't seem to agree. He took every opportunity to signal that rate hikes are off the table for the foreseeable future. This started with their statement that the Committee will be patient as it determines what future adjustments to ... the federal funds rate may be appropriate, but it didn't end there. During the press conference, Powell talked about cross-currents or slowing global growth several times. He also said he would need to see faster inflation before he would see a need for greater rate increases. That's a change in tone from the past, where the Fed's own economic projections showed steady inflation but a series of rate hikes. He could have easily vacillated, emphasizing data-dependence and while they aren't hiking now, they could be later. He didn't. That was on purpose. Does the Fed Know Something We Don't? This is a very tempting conclusion. I'm usually not one to jump to these kinds of conclusions, but I think it is fair to assume the Fed fears things are worse than they look now. Otherwise this about-face on rate hikes seems premature. What are those fears based on? Probably conversations with business contacts and their non-U.S. counterparts. The Fed relies quite a bit on a semi-formal network of business contacts that both the Board and the regional presidents have, and if they have turned more negative the Fed is going to listen. My take is that eurozone and Chinese growth are slowing rapidly and they aren't sure how that will impact the US. Is Powell Caving to the Stock Market? A little bit, yes. I think in November and early December, Powell was treating the stock market selloff as just normal volatility. Something convinced him that it was more worrisome, though. Again, I suspect that wasn't just the depth of the selloff, but that the selloff coincided with warnings from business contacts that demand was slowing. However, I do think he will take financial market signals a bit more seriously going forward. That being said, be careful getting bullish on risk here. In my experience, risk assets can't rally if economic activity is stalling, no matter what the central bank does. If you are going to buy stocks here, you better think the economy is going to resume growing. Don't just bet on a Fed's gonna save us rally. It's a fool's bet. Trade Ideas Stay long interest rate risk. I've been net long bonds for a few weeks now, and while rates have been a bit volatile, we haven't set a direction yet. I still like this trade. I'm specifically underweight/short 20-30 year bonds and overweight/long 5-10 year bonds. I still don't like TIPS. TIPS are crushing Treasuries Wednesday, but I still don't love the trade. 5-year TIPS are OK if you put a gun to my head, but they probably only work if oil prices rebound. The thing is, if you think oil prices rebound there are much better trades. Even in bonds specifically, energy credit remains very cheap. The credit has more outs. The 5-year TIPS yield 0.78% + inflation. BBB-rated energy bonds yield 4.5%, and BB-rated is going to be in the 6-7% area. You don't need oil to rebound in a big way to make decent money on these credits, just stay steady. The TIPS need a real rebound. Still not short USD, but watching EUR. I want to be long EUR vs. USD, but haven't gotten the entry I want yet. I'm OK with being short USD generally if you wanted to buy something like Invesco DB US Dollar Bearish UDN. I'm personally waiting for an entry into EUR. Could get it on Friday if the US jobs number is strong.

Does the Fed Know Something We Don't?

The Fed is bending over backward to be dovish.

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