Unedited Guest article:“Waiting for Godot” (and more Butterfly Wing Flaps): a Fed turn embarking on a series of rate cuts may be significantly further down the horizon than market participants are now pricing in
5 December 2023, Ohio; USA
While it now appears the Fed hiking cycle over the past nearly two years has come to an end at a terminal rate just north of 5% (as a previous commentary I authored improbably explored and predicted well back in December 2021), traders are probably pricing in an overly dovish Fed once again. Hope springs eternal – as imagined and renewed Fed “quiescence” has been the story perpetually of this most recent cycle as traders perceive big money can be made early by frontrunning a Fed they falsely believe they can manipulate (compared to being late on a Fed turn down the road).
Personally, I don’t think the US economy is falling apart (and neither do real time “GDP Now” estimates from the Atlanta Fed). Moreover, we’ve regularly but erroneously grappled with the narrative of a systemic break or buckling in a vulnerable interest rate sector of the market (like regional banks, commercial real estate, or residential housing (under the collective weight of the most aggressive Fed hiking cycle in at least the past 35 years). But despite all these “logical” storylines of sector malaise and associated transmission effects to the broader economy, it is exceedingly rare for the Sky to Fall, especially since the US economy has many ballasts. Those include the US consumer who was denied the opportunity to spend and live during long and dark spans of the recent pandemic – who equally and capably refinanced his/her fixed rate home mortgage at the lowest interest cost in generations (accruing significant additional spending power as result).
Furthermore, I think the odds of a systemic sector “break” somewhere in the capital markets are receding rather significantly (because the Fed stopped hiking) and the market has brought rates down considerably over the last 45 or so days across the curve (which will act as shock-absorber and emollient for “stressed” assets around the globe).
As such, I don’t think there’s reason for the Fed to wave the White Flag of “surrender” at this point, especially as they would lose all credibility if inflation ticked up again after what would be a premature cut. Notably, inflation is arguably becoming more endemic too – because a full employment economy means Labor finally has negotiating leverage, arguably for the first time in decades.
That’s bolstered by an industrial renaissance which is bringing jobs back to America and a national security policy which is leading to reshoring of investment and CAPEX.
Not to oversimplify but offshoring is deflationary while reshoring is inflationary! These are BIG factors and dominant trend changes (that are rather immutable) underneath more contemporaneous weekly and monthly data – and will make the Fed’s current inflation battle more determined, prodigious, and persistent than the current two year skirmish.
As illustration of how long these international investment cycles take to change (like offshoring and the rejection of Just in Time inventory sourced and produced abroad), it took arguably the Six Sigma combination of the heightened Chinese economic and national security threat combined with the Covid-19 pandemic, combined with the Russian invasion of Ukraine to finally lead these formerly deep ingrained production phenomenon to reverse in response (namely reshoring and reinvestment in American industry). Thus, geopolitical tremors and risks laid bare (accentuated by the shockwave Butterfly Wing Flaps of a global pandemic) now breathtakingly support full US employment and corollary wage leverage for American Labor (and possibly a longer term deceleration of the Chinese economic miracle). Talk about unintended byproducts and consequences! These industrial policy changes may also have been a realization among Democrat Party leadership that white male blue collar laborer’s votes could be lost for a generation to the GOP – unless a NEW DEAL for labor was forged (and economic “goodies” were distributed back to them), although “cultural” issues will continue to allure and appeal to many working class voters.
In any case, I believe markets (well beyond Gold and Crypto) may be positioned significantly ahead of themselves – as traders have repeatedly front run a Fed turn, to their ultimate chagrin and rue. This current episode is likely to be no different – as pre-occupation with these slow-moving but tectonically powerful factors (like reshoring and reindustrialization) are very likely to lead to great prudence and patience by the Fed. That’s especially since the Fed won’t (and CAN’T) let themselves be rolled by markets. Moreover, the so called Fed “Put” will not be nearly as vaunted and reliable as it was in the previous deflationary era which lasted more than one generation (as the Fed “Put” can’t be operative to nearly the same degree in the inflationary era we’re now living in).
That’s as the Fed would lose all credibility if they cut too early before inflation is vanquished – which it WON’T be for arguably a very long time (due to the dramatically different economic and security environment we now confront) as elucidated above.
Beyond these factors, I’d also point to the enviable unanimity Fed Chairman Powell has forged within the Fed. Despite stressful circumstances the Fed Committee has faced (navigating interest rate policy during murky and unprecedented macro-economic crosswinds), there have been only two dissents combined among Federal Open Market Committee voters during calendar years 2022-2023, while the Fed hiked interest rates by a collective 525 basis points. So even though Chairman Powell was first appointed by President Trump and was subsequently reappointed to a successive four year term by President Biden, Federal Reserve policy has been guided in a non-partisan manner with great equanimity during perilous and unprecedented times.
Contrast this oasis of institutional harmony, productivity, purposefulness, and the spirit of public service with the dissonance, derision, division, and dysfunction elsewhere in Washington, D.C. (particularly in the US House of Representatives and the Supreme Court) – and remember some in Congress would even shut down the US Government nor raise the US debt ceiling to make distorted political points. Irresponsible and elliptical actions like this would raise the Term Premium investors charge the US Government to borrow as they lose confidence in US institutions and long dated Treasury Bonds (which then only serves to further increase US deficit financing costs) – when reducing US debt levels is supposedly the grand reason the US Government should be shut down in the first place. In essence, why would Chairman Powell become less reflective and inclusive now (and respond precipitously to markets) when he has consonance and confidence within his Committee, when we need poised adults at the helm, and when the Fed has rather decisively supplanted the US Senate as the “world’s greatest deliberative body”?
In sum, unless one sees the US economy collapsing into a significant recession (which I don’t) or a true systemic fissure in a major too big to fail sector (like regional banks or commercial real estate which hasn’t happened yet, despite some cracks), I think traders should re-read “Waiting for Godot” (and potentially glean non-Western conceptions of time (like those implied in Japanese Candlestick Charting Techniques) – as the Fed will likely prove patient for longer than anxious (and potentially chastened) traders can afford. Maybe traders could acquire a little more humility in the process too, as “Waiting for Godot” (beyond its worthwhile philosophical and ethics lessons) reminds us of the Illusion of Time – and how small we individual humans are compared to these big tidal forces of national security and inflationary reshoring which will act as institutional brakes on an earnest, thoughtful, vigorous, and resolute Fed.
Guest article by Mr. David Schane
david_schane@hotmail.com