By Michael Every of Rabobank
We were lower for longer. Then we were higher for longer. Now we are going to be wronger for longer.
After all, the Fed, while holding at 5.50%, saw big increases to its projected rate of GDP growth (from 1.0% to 2.1% in 2023, and from 1.1% to 1.5% in 2024), big downward revisions to unemployment (from 4.1% to 3.8% in 2023, and from 4.5% to 4.1% in 2024), and yet an optimistic downward revision to core PCE inflation for 2023 from 3.9% to 3.7%, with 2024 the same at 2.6%. The dot-plot still projects one more 25bp hike this year to 5.75%, and Fed Funds was revised up by 50bps in both 2024 and 2025 --so now two cuts of 25bps in 2024, not four, five in 2025, and four in 2026-- and Fed Funds is seen at 2.9% in 2026, 0.4ppts above the previously assumed long-run rate. Powell noted during Q&A that some at the Fed have raised their estimate of the longer run rate, but this did not show up in the median.
As a result, US 2-year Treasury yields at 5.18% were +13bps from pre-Fed, +9bps on the day, and the highest since June 2006. 10-year yields were 4.41%, +10bps from pre-Fed, +5bps on the day, and the highest since December 2007. The DXY index at 105.4 is heading back towards its 2023 high, though many EM FX will be breathing a sigh of relief that oil was down around 1%. (So, when do we get the next supply cut from OPEC+?)
Yet after the ECB rate hike to 4.00% last week, weaker-than-expected UK CPI yesterday ahead of the coin-toss BOE today, and the Fed holding, some are again salivating at the prospect of a rates pause and an imminent cutting cycle. Some even think we might be heading back to zero, with some cause given past performance.
I dub that approach “Wronger for Longer.” Put simply, if rates fall in 2024, we are still very unlikely to be going back to the post-2008 ‘New Normal’; and if we are, where rates sit is going to be less important than where you are, given the powder-keg under us socio-politically and geopolitically.
Crucially, Philp Marey, Elwin de Groot, Bas van Geffen, and Ben Picton all agree that while rates will fall in 2024, they are not going to fall fast or far. Indeed, on the Fed, Philip argues the floor may well be as high as 3.5%. Yes, that’s lower than 5.5%, where he sees the peak. However, it’s far too high for a swathe of the market and economy predicated on zero or negative rates. After Merkel’s statue toppling, art again imitates life: a few years ago, people were paying silly money for a banana taped to a wall; now, ‘Danish artist told to repay museum €67,000 after turning in blank canvasses’. There’s no time for that shtick when you can earn decent interest.
Moreover, even a 3.5% Fed Funds floor would be relatively higher than in many other economies. If you think Europe, Japan, or China will be raising rates, or not matching Fed easing, when US data turn south you are going to be very wrong. How long for is up to you.
Imagine the pain in pockets of the vast global Eurodollar market: and the naiveté of those thinking the Fed will bail everyone there out even as the geopolitical and geoeconomic architecture fragments. “What have you done for me lately?” will be the Fed tune when a failure to rewind all of its recent tightening sees cascading Eurodollar credit failures.
Yet the Fed specifically and central banks in general are also likely to be wronger for longer. As Philip notes:
“We do not share the Fed’s optimism about a soft landing, and we think it’s more likely to see a deterioration in the economic data before the November meeting, averting additional rate hikes We expect the US economy to fall into recession in the final quarter of this year as a result of the lagged impact of monetary policy. We find the FOMC projections too optimistic, not only because they reflect a soft landing, but also because we have some doubts about the smooth return to the 2% inflation target.
First of all, core services ex-housing remains a wild card, closely related to nominal wage growth. Even the FOMC has to admit that it is not clear yet that this is under control. Recent strikes suggest that labour is still seeking compensation. What’s more, any negative supply or positive demand shock could set off another spell of inflation. We only have to read the daily news to see that the world economy is more likely to experience negative supply shocks these days compared to the past.
Therefore, we think that the FOMC’s inflation projections are only realistic if nominal wage growth slows down rapidly, and further supply and demand shocks remain absent. However, in reality inflation may be more persistent than projected by the FOMC. In combination this means that our forecasts are more stagflationary than the FOMC’s: we expect both more economic stagnation and more persistent inflation. A recent study by the IMF paints a sobering picture about the effectiveness of previous attempts across the globe to get inflation back under control.”
Indeed, Philip believes we could also see upward revisions of the longer run Fed Funds rate in upcoming FOMC projections. That would certainly shake financial markets up as:
The US signs a new Partnership for Atlantic Cooperation, an embryonic NATO-meets-In-Deep-Ship pushback against China’s maritime Belt and Road. That’s as former president Trump floats using the US Navy to blockade fentanyl imports coming in – presumably not at the land border;
The Financial Times asks ‘Can Europe go green without China’s critical minerals?’ The answer is only at a very high price in a process described as akin to repairing a car while driving it.
The striking UAW carried out strikes at three US plants as a warning. They now have Trump’s backing - if they oppose EVs entirely. (As UK PM Sunk also flip-flops.);
On the labour front, Trump talks about using the 1798 Alien Enemies Act --last used by FDR in WW2 to keep Japanese Americans in internment camps-- to deport non-citizens;
Lina Kahn’s FTC ratchets up its anti-trust case against Amazon; and
The US lurches towards potential shut down before what some suspect will be pre-2024 giveaways to the electorate.