FaireCapitalist

The summary from Powell today is that he felt the need to remind the market that the Dot Plot issued 2 weeks ago was still accurate even though the market had immediately thought the Fed would just be more dovish than what they said. In that dot plot, 18 of 19 members were thinking only 50bps of total cuts for the rest of 2024. So Powell came out to tell the market this remains the base case so it is time to start removing some of the cuts the market was thinking were in. He also read a scripted response about better than expected data out last week on GDI and spending/income revisions which have removed some of the downside fears/risks that the Fed had before. For a guy that is typically dovish, this wasn't that. In order to get the aggressive pace of easing desired/expected by the market, the economic data will need to get reasonably worse first from here.

The Fed will not be able to bring inflation back down to target until they introduce dual sided risk to their next move. The current asymmetry in their policy setting framework where the bar to cut is lower than than bar to hike is flawed and continues to be self-defeating. Despite the fact that inflation, labor market and growth all remain more robust than expected, the Fed is too reluctant to introduce the possibility that their next move can be a hike even though conditions today are rosier than they were last fall when a "substantial majority" of Fed members still expexted to raise rates in 4q23, something they failed to deliver. This reluctance to contemplate a hike means that the market will keep financial conditions loosr, continue to enable animal spirits to exist and sell volatility, driving up snd unanchoring inflation expectations and pushing actual inflation higher, making that last mile achievement of 2% inflation basically impossible. Having the market believe that their next move can be either a hike or a cut will go a long way toward helping to slay animal spirits, tighten financial conditions, lower inflation expectations and ultimately inflation. Yes, this will lead to a significant asset price correction but unfortunately, that is the price to be paid for a Fed that got too cute last fall thinking they could achieve the "golden path" of immaculate disinflation without more pain and then didn't understand how a significant loosening of financial conditions would filter thru the economy.

After the one-two punch of a hotter CPI and awful 10 year auction today, risk markets are on the brink of a larger move lower as investors rapidly price out rate cuts starting this summer and increase the odds that no cuts are coming this year and that the next possible move could be a hike. Tomorrow will be action packed as we get the PPI data in the morning which along with the CPI today data will help set the stage for the core PCE estimates to firm up for the month of March (data out at month end). A hot reading on PPI is going to drive up estimates for core PCE while continued strength in oil/gasoline on heightened geopolitical risks figure to keep headline inflation momentum moving higher as well. We get alot of Fed speak tomorrow (Williams, Barkin, Collins, Bostic) which should help give some clarity about how the committee is going to react to this inflation re-acceleration story now through its third month of the year. We need to hear a Fed that is open to the idea that it may need to be hiking rates again in order to slow momentum and that cuts this year are not assured. On Friday, its more Fed speak with Schmid/Bostic/Daly but also the important UMich survey on inflation expectations, which I think is likely to positively surprise given the historically strong correlation between this indicator and gasoline prices which continue to rip higher and are up yoy. Rising inflation and inflation expectations de-anchoring suggest the need for the Fed to do more tightening. Since they are not going to move on more aggressive QT like I think they should, the only lever they can pull is the rates lever. They need to talk tougher about the potential to remove the cuts this year and possibly hike. Only then can we get the asset correction necessary to stomp out animal spirits and bring down inflation so it doesn't become an election issue this fall. Chart of the Day - SFRZ4 vs IWM - Jaws of Death

Hypothesis Continued: While the February 2022 decision to sanction Russian reserves and remove them from SWIFT post the invasion of Ukraine will be seen as a major spark that accelerated the decline of the UST as the world's hegemonic neutral reserve asset, I think that we will look back to the August 2023 BRICS meeting and inclusion of oil producers Saudi, UAE and Iran into the group as the straw that broke the camel's back. Folks mistakenly saw this meeting as a failure to deliver an alternative BRICS currency but in reality, what it did was re-introduce gold as a neutral settlement asset allowing countries to trade goods in local currencies and settle any excesses in gold. This is exactly what BRICS wanted. Immediately after this meeting, we saw what looks in hindsight like an engineered attack on the UST market where a strong move higher in crude oil prices (coordinated?) forced foreign UST holders to sell USTs in order to raise US$ to pay up for more expensive energy. Term premiums rose, equity prices cratered and the UST market sold off materially on what were relatively minor drops in the foregn holdings of USTs according to TIC data. Yields went up significantly in this Sept/October period and seemed to scare the shit out of the Fed and Administration. So it seems Yellen and Powell went to the October IMF meetings in DC to discuss with allies a plan to get them to slow down the UST selling and they were then able to engineer their dual policy pivot on November 1st. Yellen surprised markets by announcing less UST duration selling than the market was expecting while Powell basically removed the final rate hike expected by the Fed in 4q23. This coordinated plan led to a drastic loosening of financial conditions that led yields lower and removed the pressure on the bond market to give the US time to figure out a longer term way to slow down foreign UST selling. Enter non-USD buying of oil. By blessing the ability of our allies to buy energy in currencies other than US$ (China and India already were doing it), this would slow down the need for them to sell their UST holdings to get the US$ necessary for them to buy oil. It has now become in the US govt's strategic interest to want our allies (and other UST holders) to buy oil in local currency to provide them the incentive not to rapidly sell down their UST holdings when they need US$. The US spent trillions of dollars over decades to prevent countries from buying and selling oil in currency other than US$ but has now flipped on that view to slow down the selling and realizes it is in its strategic interest to do so. This plan went into full motion at the San Francisco G20 meetings in November where they cleaned up the city for Xi and MBS. As long as the world sellers of oil settled excess trade balances in gold and not by buying the government bonds of the importing nations, the US would be ok with the arrangement. It's clear that BRICS countries were already behaving in this manner and I believe now Japan and possibly Europe are allowed to do so as well. The economic warfare is being fought at the highest levels and it seems like BRICS scored a major victory last fall. The US decision to sanction Russia was a strategic error in hindsight but doesn't have to be the fatal blow if the US now embraces a multilateral currency world that allows a weakening of the US$ to assist the rebuilding of supply chain and the rebuilding of our domestic manufacturing base. Only time will tell how this plays out. Trade accordingly H/t @LukeGromen as thought leader on this view. @wmiddelkoop @LawrenceLepard @Convertbond @KingKong9888

The Federal Reserve has introduced its own version of a Financial Conditions Index which they publish monthly (just released on 3/22 through February) that "can be used to gauge broad financial conditions and assess how these conditions are related to future economic growth. Higher figures denote tighter financial conditions, lower figures denote looser financial conditions. The baseline index measures how financial conditions affect the economy with a lag of up to three years and an alternative index allows lags of at most one year. Fed President Logan mentioned earlier in the year in a speech where she expressed concerns about loosening financial conditions making the Fed's job more difficult to bring inflation back down to 2% specifically these indicators as being two of the four indicators that she looks out (the others being the Chicago Fed Financial Conditions Index and the Goldman Sachs Financial Conditions Index). As a result, I think it is fair to suggest that these Fed indices (charts below) are the Fed's main indicators to show whether or not financial conditions are restrictive and to what degree these financial conditions are impacting the economy, either assisting or detracting the Fed's ability to achieve its inflation target. With the February data just released, we can now see that the Fed's two main indicators of financial conditions have shown a drastic loosening of financial conditions since last summer with the series using a 1-yr lookback suggesting that financial conditions are no longer restrictive (negative numbers) and getting increasingly less restrictive. The Chicago Fed indicator (also below) of financial conditions is suggesting that conditions are as loose as they have been before the tightening cycle even began. When asked about financial conditions at the press conference, Chairman Powell said that they are still restrictive and providing some pressure on growth and on inflation. He either doesn't get to see the Fed's own data or he is lying because the data clearly shows that not only are financial conditions not restrictive, but they are probably accommodative at this point. The reason this is important is that the loosening of financial conditions filters quickly through to the real economy, supporting growth (especially in interest rate sectors) as well as into inflation and inflation expectations. Animal spirits re-ignited by a Fed Chairman that doesn't believe financial conditions are loose is only going to further threaten to de-anchor inflation expectations which have already been moving higher for months as well as lead to a re-acceleration of actual core and headline inflation in the coming months. He is drastically increasingly the likelihood of a second wave of inflation and for inflation to become an election issue. As I have been discussing, until and unless the Fed acknowledges that it's policy is not restrictive enough to bring down inflation towards 2% in a timely manner, and thus needs to do more tightening and/or more aggressive QT, financial markets are going to continue to rally inflation related assets (gold / oil / commodities / BTC / stocks) until the point at which the Fed becomes uncomfortable that inflation expectations are no longer well anchored and that their next interest rate move could actually be a rate hike. Introducing volatility into the interest rate market is the first step toward showing that the Fed is serious about achieving this mandate. There are 9 Fed members that are looking for 2 cuts or less in 2024 with 3 voters (Bostic, Bowman and Barkin) that are likely looking for zero or 1 cut. I suspect Waller (author of the "What's the Rush" speech and Mester (also both voters) are at 2 cuts. That means there are 5 voters who currently would not be supporting the start of a rate cutting regime given this inflation background unless the labor market showed sign of imminent and significant deceleration, something that really is not expected at this point. I don't believe Powell is going to look to start a rate cutting campaign without unanimous consent in an election year otherwise he would run the risk of this decision being seen as highly political. So I think there is a lot of wood to chop for him to convince the rest of the committee to get going in supporting a rate cut. Powell's dovish performance may have been his effort to try to put some pressure on other Fed members to get onboard but the gaslighting from this press conference about financial conditions still being restrictive is ridiculous, even when looking at the Fed's own indicators. We need a @federalreserve and a Fed Chair that are serious about bringing inflation back to 2% and what we saw last week ain't gonna get us there. Markets will continue to move in a disturbing direction for the Fed, threatening to de-anchor inflation expectations, until they course correct. @NickTimiraos @dampedspring @DannyDayan5 @LukeGromen