Glad to be back, I know I missed you with an article last week- we’re in the middle of transferring over to Substack (happening soon) and also building my next macro guide titled The Four Foundations Of Macro, which will be out in March.
I’m pouring out a lot of time and attention into this one. Major value jam-packed.
It won’t be free.
As for now, there’s a clear disconnect between financial conditions and the Fed’s economic outlook, so let’s take a dive.
“A Soft Landing” - Jay Powell
“Reducing inflation is likely to require a period of below-trend growth and some softening of labor market conditions.”
— Jay Powell, Fed Chair at FOMC Press Conference
Pretty explanatory right?
Well, you would think so but what sticks out most is his choice of words which is why both markets and investors perceived this press conference to be rather dovish compared to what we were expecting Jay Powell to deliver.
In December we received the Summary of Economic Projections from the Fed, and according to that economic projection, unemployment was forecasted to rise 110bps over the next 12months starting in 2023. Shown below in figure 1.
The word “some” doesn’t present the full picture to the markets but rather a disconnection in his tone and overall economic policy moving forward. Why do I say that? Well, there has never been a period where unemployment has risen by 100bps or more without a recession occurring over the same time span. Something I actually highlighted in my last piece.
Jay Powell’s dovish tone came as a surprise to me and to many other market participants especially after his December press conference where he emphasised the importance of seeing “non-housing-related core services” decline steadily whilst maintaining interest rates higher for longer.
However, it wasn’t all doves; he reiterated how:
“The historical record cautions strongly against prematurely loosening policy.”
— Jay Powell, U.S Fed Chair
But the market completely disregarded this comment, showing clear signs that investors and market participants believe that the end of the tightening cycle is nearing upon markets, meaning high beta assets/stocks are the play to make. Signal the reddit traders, again.
During the questioning at the press conference there were a few questions that stood out to me as important, mainly this one from form Chris Rugaber:
“As you know financial conditions have loosened since the fall with bond yields falling, which has also brought down mortgage rates, and the stock market posted a solid gain in January. Does that make your job of combating inflation harder? And could you see lifting rates higher than you otherwise would to offset the increase in -- or to offset the easing of financial conditions?”
— Chris Rugaber, Associated Press
In other words, isn’t the disconnect between financial conditions and the current economic policy clear enough for you Jay Powell?
Well let’s take a look at one of my favour indexes, the NFCI (National Financial Conditions Index).
I’ve put a link here to this index here, so that you can get a better look. But what I want you to focus on is the latter end of the index which is circled. Since October 2022, this index shows us that financial conditions in the U.S have been loosened significantly, credit and leverage are both increasing alongside appetite for risk, to make things worse the press conference held on Wednesday only added to concerns that financial markets/conditions don’t believe there will be a hard landing or a recession.
Take a look at chart above, this is exactly in line with figure 3, the NFCI. Since October 2022, national financial conditions have been loosening, alongside that yields have been declining across different maturities with the 10Y now yielding 3.3885% at the time of writing. The question from Chris correctly stated that lower yields across USTreasuries have influenced mortgage rates also leading them lower which is contrary to the Fed’s current mandate which is to strip demand from the market and bring financial conditions back down.
The short end of the curve has received the most steepening due to the immediate hiking, but in the derivatives and futures markets traders are betting on two more hikes from the Federal Reserve before rate cuts come in towards the end of the year.
If you ask me, their bets are justified, but I still think there’s some way to go before we see any form of rate cuts; something which Jay Powell reaffirmed but markets shrugged off with ease.
“I don't see us cutting rates this year if we get if our outlook turns true,”
— Jay Powell
However, comments like the one below give risk assets a boost as you’re indirectly telling market participants there will be a soft landing, nothing to worry about, which isn’t the case.
“I continue to think that there's a path to getting inflation back down to 2 percent without a really significant economic decline or a significant increase in unemployment.”
— Jay Powell
My view is simple, we’re in a deflationary environment but financial markets and conditions need to be brought back into place quickly if we wish to return to a stable level of inflation, easing financial conditions creates a bedrock for a rebound in inflation and for asset valuations to become unjustified. As for now, I have no change in perspective, a weaker dollar remains my outlook, and even though I’m not a buyer of ‘Fed pivot’ at this moment, equities remain a positive allocation of capital.
As always, thanks for reading until the end MMH crew.
I’m working extremely hard to get this macro guide across to you and finish my website which will have some more free resources/material.
The Four Foundations of Macro FX will be out end of March, I’ll do a promotion for the early birds who get this guide within the first 72hours, after the price will remain unchanged! More info to come.
Until next time