"The worst mistake we can make would be to fail. We have to restore price stability."
-- Federal Reserve Chair Jerome Powell
The Montreal Expos
On Wednesday afternoon, the Federal Reserve closed their June policy meeting and produced an "official statement," as they do eight times a year. The FOMC also produced their economic projections that include the famous or infamous "dot plot" that has long outlived its usefulness as a tool of forward guidance. These projections are published quarterly. They often change profoundly over the three months in between releases.
Wednesday's edition was no different.
The change made to the target for the fed funds rate caused an algorithmic response across financial markets, that in turn provoked a short-covering. Remember, many high-speed algorithms read keywords such as those released as internet-based headlines. This probably triggered some short-covering. Again, remember that enough hedge funds came into the event overwhelmingly short.
The headlines blared: "The Federal Reserve Bank raised the benchmark interest rate (the fed funds rate) by 75 basis points, the largest increase since 1994." In other words, it's been a while. The top TV shows were "Seinfeld" and "ER"... the best team in baseball was the Montreal Expos.
The move left the target range for the fed funds rate at 1.5% to 1.75%. Interestingly, there was but one dissent, that being Kansas City Fed President Esther George, who wanted to increase the FFR by only the 50 basis points that Jerome Powell and other Fed officials had signaled well ahead of time. This, I found so interesting, because while it is obvious that the FOMC was influenced to get more aggressive at this June meeting in response to hotter-than-expected May consumer prices and probably used the Wall Street Journal to signal the marketplace last week, Esther George has a reputation as possibly the most hawkish official at the central bank.
This (Thursday) morning, futures trading in Chicago are now pricing in an 83% probability for another 75 basis point rate increase to be made on July 27, with a 17% chance for only a 50 basis point rate hike. Assuming a 75 basis point hike at that time, futures are also pricing in additional half percentage point (50 bps) hikes on September 21 and November 2. These futures markets see the FOMC topping off all of this action with a 25 bps hike on December 14 to close the year with a fed funds rate of 3.5% to 3.75%.
The Statement
As there were no surprises in the action taken, as long as one paid attention late last week, there were no surprises in the official statement. Most of the statement was cut and pasted from the prior statement prior (May 4), with perhaps one key takeaway that now resonates more than anything else.
The FOMC added the sentence: "The committee is strongly committed to returning inflation to its 2 percent objective." This replaced a line stating that the FOMC "expects to return inflation to its 2 percent objective." Same meaning. Less confidence.
The Projections
This is where I became alarmed on Wednesday afternoon. I told listeners this on TheStreet's FOMC Twitter Spaces hosted by Katherine Ross, and I told viewers this on Fox News with anchor Neil Cavuto.
If one was not stopped by the Atlanta Fed's revision to its GDPNow real-time second-quarter model that came in the wake of the poor May Retail Sales report, then the FOMC's projections should have. First, Atlanta took second-quarter GDP growth down to 0.0% from 0.9%. Remember that the U.S. economy contracted (-1.5%) in the first quarter. This brings the U.S. economy directly to the doorstep of a statistical economic recession. Time for all of the politically driven economists who told us that a recession was not in the data to pipe down. The data has brought us here.
Then, after that kick in the pants, we take a gander at the FOMC's projections. The committee took their median expectation for 2022 GDP growth down to 1.7% from 2.8%. Understand this, while that revision appears harsh, if the first quarter printed at -1.5%, and the second quarter holds at 0.0%, then this economy is going to have to rock louder than a Kiss concert over the final six months of the year just to finish 2022 at the Fed's new, lowered projection. Probably not happening, unless Covid simply vanishes and peace breaks out immediately in Europe.
To make matters worse, the FOMC does not see 2% GDP growth for any future year. Think about that. For years, we complained about the U.S. economy's sluggish 2% trend rate for growth. If the Fed is right (one bit of solace: they never are), the economy will grow 1.7% in 2023, 1.9% in 2024, and 1.8% for the "longer run." In other words, what used to be considered barely satisfactory economic growth has become "a bridge too far" possibly forever. Awesome.
Beyond that, the Fed sees 2022 PCE inflation at 5.2%. Understand that while CPI has been running with an 8 handle, the PCE printed at 6.3% growth for April (we don't have May yet), so this is realistic and translated into something far more uncomfortable if converted to CPI. I think the Fed is trying to price out their contribution to inflation, while leaving by necessity all of the inflation created externally (Russia, China) and fiscally (Obama, Trump, Biden, the Legislature).
Assuming the economy goes into recession, which as an economist, I am fairly certain of, I think the Fed's projection for Unemployment is wildly optimistic at 3.7% for 2022, and 3.9% through 4.1% for years going forward. We go into at least a nominal recession and the whole ballgame changes. There is no effective method for projecting the impact of such an eventuality upon both business optimism and consumer sentiment.
Once economic activity is acknowledged as being in a state of contraction, then we'll find out how deeply businesses cut back on expenses, including payroll. Then we'll find out how much households need to cut back in order to sustain a certain standard of living. Credit-card usage already suggests serious strain in this area. The nonsense about stronger consumer balance sheets is largely just that -- nonsense. I believe that lower-to middle-income households have already been living in a recession-like existence for months.
The Balance Sheet
No changes nor surprises here. The Fed reiterated the current plan to let $47.5B in maturing debt securities per month roll off of the back end of the portfolio for now, ramping up to the expected long-term rate of $95B per month by September.
Readers know that I am more comfortable sucking liquidity out of the economy in this way than I am in attacking the front door. I would have no problem with the Fed if it were to choose to at least experiment with the outright selling of its mortgage-backed securities as they never really belonged on the balance sheet in the first place. The Fed, as usual, does not appear ready to take my advice on this matter.
My Thoughts
I have been trading these markets for a fairly long time. I have never seen a financial market downturn end on its own... without the Fed having turned dovish in posture as a catalyst or in response to some crisis-level situation.
The Fed projects a fed funds rate of 3.4% for 2022, which is almost, sort of in line with the 3.5% to 3.75% currently being priced in by Chicago. The Fed sees an FFR of 3.8% in 2023. That means to me that the Fed expects to have to battle with consumer-level inflation at least through the end of 2023.
Then one sees that the Fed (though outlooks this far out are ridiculous) sees the FFR at 3.4% again in 2024, and just 2.5% in the longer run. That means that the Fed expects to be easing policy again by 2024 -- assuming that substantial progress has been made on inflation by that time.
You guys follow? I don't have a crystal ball, but the Fed is expecting to be hawkish through the end of next year and does not see a truly robust economy at any point in our future.
In regards to a Fed put, the S&P 500 has been batted back and forth in terms of valuation between 15.7 and 16 times 12-month forward-looking earnings of late. The Fed, at least in recent to semi-recent years, has not come to the market's rescue until the S&P 500 trades at a rough 13.5 times forward-looking earnings.
The implication would be that the S&P 500 could, in theory, have to give up another 14% or so, before the Fed, at least under Jerome Powell, would feel compelled to step in. Again, this assumes that there has been significant progress in fighting inflation.
Wednesday's Rally
Wednesday's market rally was likely a tradeable event driven by keyword-reading algorithms and short-coverings. That rally was in no way, a signal to deploy cash in a big way. Just one man's opinion.
That's what I said last night, and I will repeat it this morning.
Economics (All Times Eastern)
08:30 - Initial Jobless Claims (Weekly): Expecting 222K, Last 229K.
08:30 - Continuing Claims (Weekly): Last 1.306M.
08:30 - Housing Starts (May): Expecting 1.7M, Last 1.724M SAAR.
08:30 - Building Permits (May): Expecting 1.786M, Last 1.823M SAAR.
08:30 - Philadelphia Fed Manufacturing Index (June): Expecting 5.3, Last 2.6.
10:30 - Natural Gas Inventories (Weekly): Last +97B cf.
The Fed (All Times Eastern)
No public appearances scheduled.
