Selective Listening Among Dueling Fed Speak

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This morning has been a banner one for those who follow every utterance from key Federal Reserve talking heads. So far today, we’ve had three of them in rapid succession. Looking at the initial reactions by stock and bond traders, we seem to have some selective listening going on. 

Shortly after 10 am EST, treasury yields dropped a quick 5 basis points and major US stock indices flipped from minor losses to modest gains. The reason was a set of comments made by Fed Governor Christopher Waller in a speech entitled “Something Appears to Be Giving.”  One of his lead points was this: “I am encouraged by what we have learned in the past few weeks—something appears to be giving, and it’s the pace of the economy.”The news reports focused on this snippet: “increasingly confident that policy is currently well positioned”.It was part of the longer paragraph:

While I am encouraged by the early signs of moderating economic activity in the fourth quarter based on the data in hand, inflation is still too high, and it is too early to say whether the slowing we are seeing will be sustained. But I am increasingly confident that policy is currently well positioned to slow the economy and get inflation back to 2 percent. That said, there is still significant uncertainty about the pace of future activity, and so I cannot say for sure whether the FOMC has done enough to achieve price stability.

About a half hour after Waller’s talk, another Fed Governor, Michelle Bowman, began an address entitled, “Reflections on the Economy and Monetary Policy.”The title of the speech tells us that this was a drier, more backwards-looking talk than her colleague’s.Her conclusion was a bit dourer, saying:

In my view, given potential structural changes in the economy, such as higher demand for investment relative to saving, it is quite possible that the level of the federal funds rate consistent with low and stable inflation will be higher than before the pandemic. In some respects, a higher longer-run level of the federal funds rate would be a welcome development, as this would allow the FOMC to more effectively respond to future negative economic shocks by lowering the policy rate. Structurally higher interest rates might also lead to less concern about the possible financial stability effects of reach-for-yield behavior, as higher interest rates ease pressure on institutions like life insurance companies and pension funds that manage extended-duration liabilities.

To be fair, no one reasonably expects rates to rapidly return to pre-pandemic levels, but her speech gave no indication that she was in the frame of mind to favor sharply lower rates anytime in the near future. 

Finally, we had Chicago Fed President Austan Goolsbee speaking as well. His address was about Midwestern farming, and thus less geared to the sort of information that moves financial markets. His opening remarks acknowledged that inflation is coming down, but not yet down to target. Again, the drop in inflation is unquestionably good news. But all three speakers made the point that they are not inclined to cut rates until inflation reaches the Fed’s target. 

Traders hear what they want, especially when it was reported that in his post-speech Q&A, Waller alluded to the possibility for a soft landing in the coming months. That is exactly what equity traders desire. But we have to wonder if bond investors aren’t hoping for something worse. A Bloomberg report stated that treasury speculators are as bullish as they have ever been, according to a JPMorgan survey conducted since 1991. We have certainly seen a 180-degree turn in bond investors’ sentiment since the 10-year rate flirted with 5% in mid-October. Stock investors’ sentiment made a similar turnaround that time. 

So, while it is understandable that bond traders would cheer the signs of economic weakness outlined in Waller’s speech, equity traders need to wonder whether that is indeed what they want. If your concern is strictly about the potential for additional liquidity, then by all means, feel free to root for a crappy economy. You may want to take into consideration whether your hoped-for cuts will materialize as quickly as you’d like. And you might also want to consider whether a slowing economy will allow the sort of earnings growth that is priced into analysts’ models. The important thing is to listen to all the various opinions that are offered, not simply the ones that ratify your views.

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Disclosure: The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the ...

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