Will the Fed retreat from its projected tightening path? Don’t look now, but the markets are already easing. The one year UST yield peaked at 2.74% November 8 and has been heading down since. The ten year peaked at 3.24% and is now around 2.84% – approaching two ’25 bp rate cuts’ in effect. I think the odds favor the one and done scenario, but wouldn’t be surprised if they don’t even get the one. Even the one and done would be a substantial cut though. The one year yield represents roughly what the market expects from fed funds over the next year. So if Fed funds topped out at 2.25%, that would amount to about two cuts in itself. As we said in A Bull Market Is Born, in any case, the “rising rate environment” is behind us, and we’re now in falling rate environment and a bull market in bonds.
Another thing to keep in mind is that it’s no longer a rates-only game. The balance sheet is in play too. It’s possible the FOMC proceeds with its rate hike but steps down or even stops its $50B a month of balance sheet runoff. This is its best option for this meeting, since in terms of outlook since it would illuminate a path out of the zero bound trap with less net tightening. That isn’t necessarily the most likely option though; less likely than the opposite case in which the rate hikes cease but the balance sheet tightening continues. Regardless, with the range of potential outcomes, this will be the most interesting FOMC decision in a long time.
In a way, it would be disappointing to see Powell and company whiff on a hike this month. The pressure from the Wall Street lobby and its media arm have grown intense, with the latter plastering its coverage with pleas from Stan Druckenmiller and the like to stand pat on rates now. Media outlets which up until now have run overwhelmingly negative coverage of President Trump suddenly have jumped into bed with him on his urging to pass on a hike now. They deserve no sympathy. After a quadrupling in stock prices in less than ten years a mere few percent giveback turns them into temper-tantrum-throwing toddlers. Had they agitated for higher rates while the bubble was inflating their cries would be more credible now. But they didn’t. For his part, candidate Trump criticized the Fed for too low rates in 2016, but forgot all about that once in office. What’s more, most of the same people pleading for easier money are still saying they see no recession on the horizon, and so are either being dishonest about their economic outlook or betraying their priorities in financial markets. If monetary policy has been turned over to Wall Street there’s much more trouble ahead.
But as for the economic effect of this meeting per se, it really doesn’t matter much whether the Fed stops now or says one last time and that’s it. De facto easing is a fait accompli.
The market implications? The only outcome the markets haven’t already priced in is if the FOMC doesn’t tip any change of course; that is that it hikes 25 bp, continues to project four more of the same in 2019, and continues its current pace of $50B/month balance sheet runoff. The chances of that are nil. Ain’t gonna happen. All the FOMC will do is ratify the easing that’s already taken place in the bond market. This in turn means that whatever other option the FOMC chooses, it doesn’t change the market outlook. Stocks will still be in a bear market. Bonds will still be in a bull market. Stocks will probably use it as fodder to kick off a so far absent Santa Claus rally. But until and unless proven otherwise consider it a counter trend rally in a bear market. The economy will still roll over in 2019. The mountain of debt built by the Yellen Fed’s continuing ultra low rate policy years too long will still be there.