Lost in Translation!
“With downside risks to employment having increased, the balance of risks has shifted. Accordingly, we judged it appropriate at this meeting to take another step toward a more neutral policy stance.”-Jerome Powell.
As the world’s largest central banks gradually move towards the neutral rate (the rate at which the economy grows at full potential with stable prices and maximum employment), this week’s FOMC failed to give guidance about the future rate trajectory.
We have termed this week’s policy as “Lost in Translation”. One of the goals of the Federal Reserve is to provide certainty to the markets and chart a sustainable policy path/guidance so that the economy and markets function smoothly.
However, with a scattered & preposterous dot plot in the Summary of Economic Projections (SEP) and an “ambiguous” press briefing, which confused market participants (some termed it hawkish while others termed it dovish), the Fed failed to provide a concrete forward guidance.
The only conclusion one can infer from the FOMC is that the Fed is more concerned about the labour market and can tolerate higher than its 2% inflation mandate to save the labour market.
We will discuss the policy in detail later on.
We also got policy decisions for the BOE and the BOJ, which were in line with expectations.
However, the BOJ surprised the markets with the announcement of tapering its ETF holdings.
We raised cash significantly this week. Despite that, we hit ATHs on Wednesday and are down 20 bps from the highs.
Nonetheless, we are up 21.82% YTD and are currently outperforming the benchmark by roughly 180 bps.
Barring any shocks/ black swan events, we expect 20%+ performance this year.
Let us dig deeper into the macro universe and comprehend the cross-asset price action.
PS: This is one of our longest write-ups ever, as we have covered a lot of nuances.
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US/Equities/Bonds/Gold/Silver/Oil/Dollar!
Some market participants believed that the FOMC outcome was hawkish because of the following statement:
I think you could think of this in a way as a risk-management cut because, if you look at the SEP, actually the projections for growth this year and next actually ticked up just a little bit and inflation and unemployment didn't really move.
As per JayPo, the Fed delivered an “insurance” cut while the markets expected a guidance of “a series of cuts” or some even expected a 50 bps cut.
Furthermore, the most perplexing part was the SEP predicting that the UR will move lower, growth higher, and inflation higher (see chart).
Considering this outcome (which is highly unlikely), the Fed, according to the dot plots, will cut by more than 50 bps in the next year.
This doesn’t make sense at all, and this vague representation of the economic projections led to wild cross-asset moves.
The 50 bps cut crowd was a disappointed lot.
On the 50 bps cut, JayPo mentioned:
You know, I think we've done – we've done very large rate hikes and very large rate cuts in the last five years, and you tend to do those at a time when you feel that policy is out of place and needs to move quickly to a new place. That's not at all what I feel, certainly, now.
I feel like our policy has been doing the right thing so far this year.
It’s crystal clear from the statement that with inflation rising, and the labour market still in equilibrium or gradually cooling, the Fed won’t do aggressive easing.
However, the focus is entirely on the labour markets now:
Our policy had been really skewed toward inflation for a long time, really. Now we see that there's downside risk clearly in the labor market. And so we're moving in a direction of more neutral policy.
So the million-dollar question here is, where is the neutral rate?
If you folks remember, we wrote last month that JayPo Jackson's speech at Jackson Hole was hawkish as he mentioned that the neutral was significantly higher than the last decade because of the headwinds known to everyone (persistent inflation, demographics, immigration, higher structural rates due to higher deficits, geopolitics/multi-polar world, etc).
When we examine the SEP, we can see that the long-run rate has been gradually moving upwards towards 3%, which, according to us, is the neutral rate (or even higher).
Nevertheless, the dot plot is a way of communicating the markets about the future rate trajectory.
The Fed miserably failed in the same as it was all over the place.
Paid subscribers will appreciate that we have been writing that there is a high probability that we shift from a “Low Hiring, Low Firing” environment to “Low Hiring, Higher Layoffs” environment. This was a concern shared by JayPo as well.
And the concern is that if you start to see layoffs, the people who are laid off won't –there won't be a lot of hiring going on. So that could very quickly flow into higher unemployment.
JayPo’s opening remarks also highlighted the state of the US economy:
“The moderation in growth largely reflects a slowdown in consumer spending.
In contrast, business investment in equipment and intangibles has picked up from last year’s pace.
Activity in the housing sector remains weak.”
While housing has been weak, manufacturing has been grinding lower slowly, and consumer spending (real, adjusted for inflation) has been faltering; the only silver lining has been the AI capex and asset price inflation, which have kept the economy afloat.
The retail sales once again portrayed the K-shaped recovery we are witnessing in the US.
We have three charts for retail sales: