Macro Trader: A (Still) Supportive FOMC

In many ways, Chair Powell & Co. have been rather kind to market participants.

Not only has J-Pow outlined two relatively clear options in terms of the next direction for the fed funds rate, he has also outlined three paths as to how we get there.

Those two options, for what it’s worth, are either for rates to remain at their present level, or for rates to be cut. If it wasn’t already clear that a rate increase isn’t under consideration Powell made it clear at the May FOMC presser, noting that it is “unlikely the next move will be a hike”. Unlikely, in central bank speak, may as well be code for ‘near impossible’, though of course policymakers must maintain some optionality in order to avoid becoming a hostage to fortune.

Of course, that brings us to the three policy paths that Powell outlined, which are:

• A rate cut, due to the FOMC gaining “greater confidence” in inflation moving towards the 2% target
• A rate cut, due to an ‘unexpected’ weakening in the labour market; presumably, code for unemployment rising above the March median SEP year-end projection of 4.0%
• Rates remaining on hold, were inflation to continue to move sideways

In short, there is no hawkish path here. If inflation remains sticky, rates remain where they are. If inflation fades, then rate cuts are on the horizon. Despite recent disappointing data, including three hotter-than-expected CPI prints, this is an FOMC that – for better or for worse – remains desperate to deliver a rate cut as soon as it plausibly can.

This rate view, naturally, must be coupled with the FOMC’s approach to the balance sheet. The pace of quantitative tightening (QT) will be more than halved, with the Treasury run-off cap cut to $25bln per month, from $60bln prior. While policymakers have gone to great extents to separate the balance sheet, and interest rates, as monetary policy instruments, this will – to many – represent a further marginal easing of monetary policy. Though this is likely to result in a smaller overall Fed balance sheet, this does drastically reduce the risk of a funding squeeze, or other financial plumbing issue, thus increasing liquidity, and supporting risk.

A supportive risk outlook, in fact, remains the base case. Not only have the FOMC not over-reacted to recent above-forecast inflation data, they have reiterated their desire to move to a looser policy stance in the near future, as soon as “confidence” on a return to the inflation target has been obtained.

This, along with the knowledge that the FOMC have the ability to cut rates aggressively, and inject liquidity if it were needed, should continue to underpin risk assets for some time to come, with the ‘Fed Put’ still alive and well, encouraging participants to move further out the risk curve. Chair Powell has shown no desire to countenance further hikes at this juncture, and is unlikely to do so.

Once more, the old adage “don’t fight the Fed” rings true, with equity bears likely to be ‘on the ropes’ for some time to come.