Don’t fight the Fed while it controls the stop-start game

Art more than science? Just two months after Federal Reserve policymakers flagged 75 basis points (bps) of interest rate cuts this year, some observers are musing about the risks should the economy take off again from here — potentially obviating the need for any cuts at all.

Seriously? In fairness, they’re just sketching scenarios and remain broadly wedded to December’s quarterly projections, even if officials remain vague on exact timing.

What seems sure is there’s no fixed model or mechanical trigger for what happens next, and clearly no rush to arms. For one, “forward guidance” — introduced over the past 15 years as a tool to guide longterm interest rates lower when policy rates hit zero and couldn’t fall any more — has all but gone for now.

The 5%-plus policy rate is the dominant lever. And data updates or business soundings now dictate the nudges, nods and winks from meeting to meeting on how that rate will evolve.

In a series of interviews last week, Atlanta Fed boss Raphael Bostic, a voting member of the rate-setting federal open market committee (FOMC) this year — talked of the “art” in the timing the first rate cut.

To a question on how the Fed will know when to cut, Bostic indicated it would be as much about professional sensibility to the unfolding evidence as any predetermined plan.

“There will be art to this,” he told CNBC. “But I do think we will get to a place where the full range of information around inflation will tell us that normalisation is closer.”

To his credit, Bostic quickly went on to detail what he was watching closely: a worrying dispersion of inflation that shows almost a third of the Fed’s favoured personal consumption expenditures basket with annual increases still more than 5%, which is almost 50% more than seen in more “normal” times.

And he fretted that the welcome fall of so-called trimmed mean core inflation gauges, which remove price outliers, looked to be “plateauing” at rates still above the Fed’s 2% target.

And so Bostic, who ’ s on the slightly hawkish side of the Fed council and forecast just two 2024 rate cuts in December, felt disinflation was “a little bumpy”.

“We just have to be patient,” he added. “Let time play out, let people get a new equilibrium and we’ll be fine.” But it was also Bostic who spoke of the risk that “pent-up exuberance” could reignite domestic demand and price pressure.

Mindful of not letting markets run away with one-way bets, all bases seemed covered.

San Francisco Fed chief Mary Daly, typically a more dovish Fed leader who predicted three cuts this year and who is also a voter on the FOMC, talked more effusively about the “unequivocally good news” on inflation.

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But she was equally hungry for more information before committing to a first cut.

“We will need to resist the temptation to act quickly when patience is needed.”

With no fixed playbook then, new year economic readouts on punchier US inflation and job creation but softer retail and industry activity still leave everyone in wait and see mode.

In some respect the Fed has, artfully perhaps, managed to communicate patience, vigilance, flexibility and determination all at once without moving policy one jot since July.

So much so that it has succeeded this year in dragging market pricing back to where it wanted it to be since December

— letting the air out of overinflated rate cut bets that emerged quickly after that meeting and which now price less than four quarter-point moves in 2024 compared with six a month ago.

And it has managed that without major disturbance, lifting long-term rates back to December levels, though still some 75 bps below October’s peaks while stock market benchmarks surf record highs.

On Tuesday, Deutsche Bank flagged what it saw as a “shallower” Fed cycle than it originally thought — 100 bps of cuts from June — and blamed inflation “persistence”.

Nuveen chief investment officer Saira Malik was gloomier and said a first cut might not arrive until the second half: “The Fed isn’t ready to spring forth.”

Don’t fight the Fed, in other words.

A similar game is at play on the other side of the Atlantic. The European Central Bank (ECB) has dispatched its hawks and doves to keep the market guessing — only for both sides to deliver a similar message of more patience and no mechanical trigger for a first move.

The upshot is that’s reshaped the market rate cut trajectory to ape that of the Fed — even though the eurozone is on the cusp of recession and the US is booming with 3%-plus annualised output growth.

Critical of the ECB’s doggedness despite a poorer underlying economic condition, Unicredit economic adviser Erik Nielsen pointed out how both sides of the debate on the ECB council were now saying the same thing “with only nuances to divide them”.

“Eurozone domestic demand has not grown to any measurable extent for almost two years

— leading to the greatest gap in per capita income growth between Europe and the US in decades,” Nielsen said.

It may be that all major central banks are just playing for time. But they may soon need to better differentiate their stances to match domestic economic realities rather than just clubbing together to corral excessive market expectations.

And that’s the point at which broader financial markets could get very frisky indeed.