While stocks remain convinced that Fed Chair Powell has thrown in the towel on hiking rates an additional 3 times in 2019, with the market now barely pricing in one more hike next year, suggesting that the dot plot's divergence with market expectations has rarely been greater, SocGen's Omar Sharif disagrees.
On the contrary, The French bank's strategist simply believes that what Powell did is merely correct for his rookie mistake from October 3.
As Sharif writes, when Chair Powell on October 3 noted that the funds rate was probably a “long way from neutral", somewhere Janet Yellen had to be smirking. After all, the former Chairwoman made her own rookie mistake just a few months into the job, when she famously noted in March 2014 that the Fed would probably begin hiking rates about "six months or that type of thing," after QE ended, which was far more hawkish than markets were anticipating. She used her bully pulpit to correct the record, and Chair Powell used today's speech to similarly correct his rookie mistake.
Powell -- October 3: "Interest rates are still accommodative, but we're gradually moving to a place where they will be neutral. We may go past neutral, but we're a long way from neutral at this point, probably."
Powell -- November 28: "Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy -- that is, neither speeding up nor slowing down growth."
So did Powell bring a “pause” closer?
Here Sharif repeats what we said earlier, which is that stating that the funds rate is now "just below" neutral, or getting close to the range of estimates of neutral, is simply factual. It does not, in SocGen's view, meaningfully shift the odds that the Fed will hike to 3.0% before pausing (the market clearly disagrees with us, as odds after the Powell headlines shifted from a total of 1.4 hikes in 2019 to only 1.2 hikes next year, below our call for two hikes in 2019 and the Fed's median of three hikes).
Indeed, reiterating that the funds rate is close to neutral simply suggests that the Fed will be a lot more careful and deliberate about each future hike, but the French bank does not think that the recent "dovish" Fed chatter suggests that they will hold off hiking, unless the data deteriorate meaningfully. In fact, Chair Powell noted today that "My FOMC colleagues and I, as well as many private-sector economists, are forecasting continued solid growth, low unemployment, and inflation near 2 percent," and that "There is a great deal to like about this outlook."
Given that, SocGen has the Fed hiking by 25bps in December but raising rates only twice in 2019 (25bps each in March & June) before stopping, which is why Sharif says that "it feels odd arguing that markets are underpricing the Fed next year." Still, even to the economist, "this repricing seems a bit extreme." Odds for a December hike linger around 80%, but March is now down to only about 50%, while June is now around 36%.
That means the odds of hiking in December, and March, and June is down to just about 14.5%.
In conclusion, SocGen notes that "Either market participants are anticipating a sharp deterioration in growth that brings GDP below potential (recall that the Fed has 2.5% next year versus 3.1% this year), or a sharp slowdown in inflation, or they think something will "break," preventing the Fed from hiking.
And sure enough, the yield curve is now steepening sharply, as always happens when heading into a recession after the curve goes flat or inverts.