“As investors, we also always have to be aware of our innate and very human tendency to be fighting the last war. We forget that Mr. Market is an ingenious sadist, and that he delights in torturing us in different ways.” – Barton Biggs

The Federal Reserve held their highly anticipated November FOMC meeting on Wednesday. As expected, the world’s most important central bank conducted their fourth consecutive 75-bps hike. However, expectations for some rhetoric indicating a gentler path for rates going forward were dashed. Markets initially rose on some language from the statement that appeared to open the door for a more moderate path. Powell used the press conference to disavow these hopes of a pause or a pivot and quite directly answered them. “It is very premature to be thinking about pausing,” said the Chairman.

It was a whirlwind for even the most seasoned pros on the Street and was likely a key inflection point in the Fed’s continued efforts to restore price stability. It’s an existential fight, as Mr. Powell pointed out in the beginning of his statement, “Without price stability, the economy doesn’t work for anyone.” Our Head of Technical Strategy, Mark Newton provides his thoughts on the initial price action and the technical state of the market after the meeting below:

The rollercoaster of price action into and after the FOMC’s rate decision proved to be dizzying for many market participants, and the specific act of Treasury yields firming after Powell’s comments proved to be detrimental to US equity markets. Specifically, the 2-year yield along with 10-year yield both showed whipsaws that caused rates to turn back sharply higher following earlier plunges. Importantly, this $SPX pullback has now given back 38.2% of the prior rally and is thought to have a maximum move lower to its 50% retracement of the October bounce, and the area at 3712 directly lines up with some key support near the former intra-day highs from 10/14. Overall, both Equities and Treasuries look to be nearing support from a price perspective, and this early November volatility should be nearing its end by Friday.

The key developments from this meeting were as follows:

Markets were disappointed in their hopes Powell may show some light at the end of the tunnel. He ended up doing the opposite and suggested that next month’s Summary of Economic Projections (SEP, or “dot plot”) would be higher than what was released in December.
While he did open the path for a potentially lower rate hike, the fact the terminal rate will likely be higher negates any joy that would come from a hike that is merely 25 bps lower.
Powell made clear that, given the tools available to him, he would rather overtighten and correct it with accommodative policy than stop tightening too early.

In the runup to the meeting anticipation had been building as rhetoric from members of the FOMC started to evolve. The September FOMC minutes had shown the body discussed potentially adverse effects of tightening. Several Fed officials were more nuanced on what was driving inflation—when inflation is driven by things on the supply-side, like gummed up supply chains, there is little the Fed can do with its monetary mechanisms. The same is true with heat in the labor market, some of this may be structural and won’t respond much to interest rate hikes, particularly in industries less sensitive to rates. Our Head of Research, Tom Lee, also pointed out that even some hawkish members appear to be tempering their aggressive tone a bit.

Several Fed speakers, including some who have been hawkish, suggested that the 2022 inflation surge is primarily from “supply chains, energy and commodities.”
This is the beginning of the doves reclaiming their voice, but it still doesn’t represent the majority view.
Thus, if the supply-side improves, there is a path for the Fed to reduce the heat quicker than the commentary at their last two meetings and Jackson Hole would indicate.

In our last installment of Fed Watch, we elaborated on the rhetorical quandary that Mr. Powell found himself after the summer rally.

The Fed must talk tough right now because not doing so undermines the tightening of financial conditions they need to achieve to bring price stability back to the economy.
If you take the Fed at face value, incremental improvement in inflation will not be enough to change course and give markets relief, so they will likely be keeping rates elevated at restrictive levels for some time.
The Fed is going to wait to see the effects of the tightening on the economy and inflation before reverting to an accommodative policy. Higher for longer is now a reality.

Since March, the Fed has hiked faster than at any time in its history aside from when Chairman Volcker had to go nuclear to stop persistent inflation. As inflation became entrenched, consumers started to expect inflation and then engage in behavior (like purchasing goods before the price went up) that make inflation a lot worse and simultaneously mitigate the effectiveness of the powerful but limited toolset that the Federal Reserve has. The aggressiveness of the current hiking cycle is largely in response to the lessons Volcker’s Fed learned during the Great Inflation. Our own research team has pointed out that the damage done to the stock market has been severe in real terms. Severe enough, that a rally to higher levels wouldn’t undermine the Fed’s desired effect on behavior via the wealth effect.

Volcker has been called the great disinflator and also had a famous rule banning proprietary trading named after him (based on his advocacy for it), Greenspan the great asset inflator and deregulator, Bernanke was referred to as the great moderator. Or Helicopter Ben disparagingly. Powell’s epithet is yet to be seen. You’ve got to hand it to the guy—he takes public service seriously. Had he chosen to hang up his spurs after the extraordinary and successful pandemic intervention, he might already be known as the great economic savior.

While other areas of the government buckled under the strain of an unprecedented pandemic, the Fed shone in keeping the wheels on and ensuring that consumers were able to weather an economic shutdown. Of course, like anything, there was a cost. The greatest inflationary pressure since the early 1980s has been at least partially caused by the pandemic largesse, necessary as it may have been. Powell wants to see this through. However, all indications are that this new task may be more fraught with risk and difficulty. Powell admitted some data was showing progress, but he wanted to play it safe. Mr. Powell very much does not want to make the same mistakes as Arthur Burns, the Fed Chairman under Nixon, whose stop-and-start approach likely made inflationary pressure worse and more entrenched.

The Fed Has Done More Than Take the Punchbowl Away…

“In the field of monetary and credit policy, precautionary action to prevent inflationary excesses is bound to have some onerous effects— if it did not it would be ineffective and futile. Those who have the task of making such policy don’t expect you to applaud. The Federal Reserve… is in the position of taking away the punchbowl when the party was really warming up.” -William McChesney Martin, October 19^th, 1955

In the pleasant discourse of the 1950s, former Fed Chairman William McChesney Martin uttered one of the most oft-cited quotes above. The reason for investor disappointment and apprehension at the Federal Reserve is largely based on the intensity of this hiking cycle and that the light at the end of the tunnel isn’t quite as visible as they’d like. If a normal Fed tightening cycle could be described as taking the punchbowl away, what the Fed is doing now is akin to breaking down the door and using the baton on guests. Powell keeps clarifying that he understands the pain could be great, but that by vanquishing inflation now he will be saving markets more pain in the future, and likely will mitigate the impact on labor markets that would normally occur given historical correlations.

What To Look for At the Next Meeting

As we mentioned, Powell has already given a big hint as to what to expect—a higher terminal rate in the dot plot. The terminal rate is very significant because of its centrality to many risk models used by institutional investors. If the data starts to settle down and we get a few prints on key statistics lower than expectations, it will be a good start, but the Fed likely needs a few of these consecutively to really change their tune.

We will be monitoring commentary from Fed speakers and the data, and we will provide any important updates
We will be monitoring the bond market to see what it is implying
We will be monitoring the housing market and other interest rate sensitive areas to assess the progress of tightening in the context of the Fed’s stated goals
We will be monitoring the inflation data closely with a mind of trying to understand what is happening in the real economy we believe this is often different than lagging indicators.

We dive very deep into the inflation data to try to offer great insights. Healthcare and Leisure and Hospitality have been the hottest elements in the labor market, and we’re not sure how sensitive those will be to Fed policy. It may be that the Fed is valuing credibility too much and is disoriented because of the anomalous data and mass structural changes going on. Even so, if this is the case, it seems to bolster their case for overtightening and fixing it with excessive accommodation. Hang in there, friends, we have evidence inflation will be successfully slain, but the Fed remains in a rhetorical box. They want the party to end and everyone to go home, not for guests to start partying again when they feel the coast is clear. They are small-town cops breaking up a kegger at this point, not slyly removing the punch bowl. However, progress on the supply side will hopefully enable them to change their tune. Who doesn’t like punch?