The Fed’s narrative

Fed Chair Jay Powell gave his semiannual testimony to Congress and principally repeated the Fed’s narrative from the January FOMC assembly. He didn’t replace the narrative with the latest information on the labor market and inflation.

So, what is the present narrative?

First, it is necessary to grasp how the Fed varieties the narrative, or what they name the outlook. The FOMC meets and principally begins with the outlook from the earlier assembly, evaluations the financial information and different developments for the reason that final assembly, and updates the outlook accordingly.

The Fed’s baseline outlook is expressed by way of the Abstract of Financial Projections. If the info obtained throughout the intermeeting interval deviates from the baseline outlook, the FOMC members collectively regulate their projections.

Presently, the FOMC expects that

• Inflation will maintain falling progressively in direction of the two% goal.
• Whereas the unemployment charge will solely barely improve from 3.7% to 4.1%.
• Which implies that the actual GDP progress will sluggish to about 1.4% this yr.
• That is what the market defines as a soft-landing outlook – slowdown however no recession.

Because of this, the FOMC expects to begin slicing rates of interest in 2024. Inflation is falling, so there isn’t any must induce a recession. The FOMC at present expects to chop rates of interest thrice in 2024. Thus, these preventive rate of interest cuts are possible to make sure regular financial progress and nonetheless close to full employment over the subsequent few years.

Throughout the January FOMC assembly, the Fed acknowledged that they want “larger confidence” that inflation is definitely sustainably falling towards the two% goal earlier than beginning to lower rates of interest.

That is the Fed’s present narrative, which the Fed Chair Powell introduced to the Congress.

Ignore the narrative

Clearly, the Fed’s narrative is backward trying, based mostly on largely lagging financial information. Thus, the FOMC can’t predict the most important turning level – their narrative shouldn’t be ahead trying.

Here is proof. Proper earlier than the Nice Monetary Disaster of 2008, the FOMC predicted in October 2007 that:

• The GDP would barely sluggish to 1.8-2.5% in 2008, after which bounce again in 2009.
• The unemployment charge would principally stay steady at 4.8% in 2008 and past.
• Core PCE inflation would additionally keep steady proper at 1.8% in 2008 and past.

However what occurred subsequent?

• The deepest recession for the reason that Nice Despair began actually the subsequent month, or probably in two months in January of 2008, with the unemployment charge spiking to over 9%.
• The whole world monetary system collapsed and needed to be bailed out by the governments.

The Fed didn’t see it coming, or a minimum of this was not included of their outlook introduced to the general public – actually a month earlier than the disaster began.

So why belief the Fed’s narrative now? It is only a narrative based mostly on lagging information or probably purposely biased – it is not a forward-looking outlook.

Right here is the SEP from Oct. 31, 2007:

So, what’s coming subsequent?

The FOMC will meet subsequent on March 21. First, they’re going to revisit their present narrative or “outlook.” Subsequent, they’ll get up to date with the intermeeting financial information and different developments. They are going to focus on the intermeeting information after which they should replace their SEP assumptions, which incorporates the projected coverage path.

What occurred for the reason that December FOMC assembly, which is after they launched their present SEP projections.

• The labor market energy accelerated, with the strongest two months of job positive aspects (December and January) over the past 12 months.

• The common hourly earnings elevated in January on the highest charge since April 2002, at 0.6% mother, that is greater than 7% annualized. Wage progress is accelerating, and this might sign the start of the wage-price inflationary spiral.

• Different necessary measures of inflation additionally present that inflation is accelerating. Core CPI and core PCE each spiked 0.4% in January, which is in step with round 4.8% inflation annualized. However most significantly, the Fed has been referencing the PCE providers ex shelter and power as the important thing measure of “sticky inflation,” and the PCE providers ex shelter and power spiked in January at 0.7% month over month, that is the very best quantity over the past 10 years! Inflation is on the rise and we may very well be initially of the brand new inflationary spike. That is what the Fed’s information exhibits.

So, the Fed will probably be taking a look at this information and different information and so they should replace their SEP assumptions.

Clearly, the Fed must improve curiosity in March, if the info is introduced like on this article. However the Fed shouldn’t be going to extend rates of interest in March. Nonetheless, the revised SEP will possible mirror lower than three cuts in 2024, which might be interpreted as a hawkish flip.

Implications

The Fed’s narrative is dangerously backward trying, and thus, it is ineffective in predicting the upcoming turning factors. The Fed Chair Powell principally repeated the Fed’s present narrative throughout his testimony to the US Congress.

Nonetheless, the FOMC should replace the December SEP assumptions after they meet in March. Primarily based on the current information, it seems that inflation is accelerating. Thus, the FOMC should flip extra hawkish.

The bond market (SHY) (TLT) remains to be predicting cuts, whilst early as June. The inventory market (SP500) is in a speculative mania, triggered by the untimely Fed’s dovish flip in December.

The Fed’s hawkish flip, which appears very possible based mostly on the current information, might trigger the bust within the extra speculative property, equivalent to Bitcoin (BTC-USD), the AI-themed bubbles shares like Nvidia (NVDA), and customarily overpriced large tech (QQQ), which might trigger a serious correction within the broad index such because the S&P500 (SPY).

Nonetheless, the most important bear market will begin with the subsequent recession, which may very well be across the nook. What number of repositioned their portfolios for a recession on Oct. 31, 2007, when the Fed launched the SEP? Probably only a few. Traders trusted the Fed’s narrative.

Provided that we’re nonetheless in a speculative mania, my S&P 500 score remains to be a Maintain, however may very well be downgraded to a Promote with the possible Fed’s hawkish flip.