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The Federal Reserve rolled out its latest statement on monetary policy which included an updated Summary of Economic Projections (SEP). Both Chair Jerome Powell’s words and the forecasts in the SEP seemed to be a play on the theme of a dovish hawkishness. The fundamental message is hawkish given the explicit reluctance to officially launch a rate-cutting cycle. The underlying message is dovish in allowing financial markets to cling to the hope of rate cuts coming some time just around the corner. From last year’s expectation of 6 rate cuts in 2024 to the current expectation of one rate cut, the stock market has generally rallied anyway. The entire dynamic makes one wonder whether these latest monetary performances even matter.

Most telling in today’s performance was Powell’s dance around the questions trying to reconcile the economic forecasts with the rate forecasts. They seem inconsistent at best and make little sense at worst: one rate cut and no further progress on inflation (core PCE (Personal Consumption Expenditures)). The quotes below come from Powell’s introductory remarks.

• A midpoint expectation for one rate cut in 2024: “If the economy evolves as expected, the median participant projects that the appropriate level of the federal funds rate will be 5.1 percent at the end of this year, 4.1 percent at the end of 2025, and 3.1 percent at the end of 2026.” Note that the current rate is set to 5.25% to 5.50%. March’s median projection was 4.6% for year-end.
• Core PCE projection for 2024 increased from March’s 2.6% to 2.8% for 2024 and going to 2.0% in 2026. Core PCE has shown no downward momentum yet this year. It has gone from 2.9% in January to 2.8% from February through April. Thus, the Fed expects no further progress on inflation this year.
• The Fed made no changes to its GDP growth forecasts: 2.1% this year, and 2.0% for the next two years.
• The Fed made a slight change to its unemployment forecast. This year stayed at 4.0%. The rate went from 4.1% to 4.2% next year and from 4.0% to 4.1% in 2026.

Put it all together, and it is not clear why the Fed wants to cut rates at all this year. I made this point last month in “Fed’s Powell Avoids Rate Cut Talk While April CPI Keeps Hope Alive” and in March in “Financial Conditions Make A Monetary Roundtrip and Undercut the Need for Rate Cuts“. Now, with no forecasted progress in core PCE inflation for this year, the Fed seems to risk sticky inflation staying sticky for longer if it cuts rates before seeing the “sustained progress” Powell talks about ad nauseam. In this latest round, Powell repeated the policy principle yet again: “we don’t think it’ll be appropriate to reduce rates and begin to loosen policy until we have more confidence that inflation is moving back down to 2% on a on a sustainable basis and that’s the that’s the test we’ve applied”.

When Powell was asked about the conundrum, I expected him to untangle the problem by indicating these forecasts are interdependent and assume that the underlying economic mechanisms that connect all these factors work out as expected. For example, one counterfactual would be a world without a rate cut in 2024 which undermines the rosy projections for GDP and employment. Instead, Powell essentially undermined the meaningfulness of the forecasts.

Powell began by explaining away the sticky core PCE with a technical discussion about lapping lower readings from last year. He essentially suggested that the sticky core PCE is an artifact of tough comparables and thus not as meaningful as it seems at first glance. More baffling was Powell’s attempt to reconcile a year-end forecast that is higher than analyst forecasts for core PCE in May while at the same time forecasting a rate cut:

“it’s a forecast a fairly conservative forecast month by month that would lead to slightly higher…12 months rates by the end of the year if we get…better ratings than that then you will see that come down or remain the same. If you’re at 2.6 2.7 [for May] you know that’s that’s a really good place to be.”

In other words, this last lonely rate cut rushing toward the departure gate looks like the Fed’s fleeting attempt to throw the market a bone and deliver permission to continue to rally in anticipation of a rate cut cycle.
 

The Teflon S&P 500

The S&P 500 went into the Fed announcement at all-time highs and trading well above its upper Bollinger Band (BB) (the black lines defining price volatility in the chart below). From a technical perspective the S&P 500 is in an extremely stretched position to the upside. The small fade into the close still left the index quite stretched (short-term) to the upside.

(Click on image to enlarge)

The market gapped up in the morning presumably on a favorable print for the CPI (Consumer Price Index). However, while Powell acknowledged the positive development, he still threw cold water on the idea that this report finally gave the Fed permission to proceed with rate cuts:

“…we see today’s report as progress and as you know building confidence, but we we don’t see ourselves as having the confidence…that would warrant beginning to loosen policy.”

I am impressed the S&P 500 held on to any gains for the day. Then again, the index, and the stock market in general, has over the course of time acted like teflon against the on-going slippage in the forecast for lower rates.
 

The Trapped Bond Market

The stock market’s teflon has occasionally emerged tarnished by rising long-term bond yields. The breakout (lower yields) for iShares 20+ Year Treasury Bond ETF (TLT) earlier in June paved the way for the latest phase in the stock market’s rally. Yet, the S&P 500 did not come down with a pullback to the previous downtrend channel. TLT’s fade from last week’s high, as Powell made the case for a dovish hawkishness, may set the stage for a new trading range that traps the bond market in a new sideways trading channel. If so, the S&P 500 can detach more clearly from the machinations in yields. To-date, the on-going expectations for rate cuts has been an important driver helping the S&P 500 eventually recover from fears over long-term bond yields even as market breadth has waned.

In the meantime, I bought TLT put options as a trade on the presumed, new range.

(Click on image to enlarge)

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