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Dow, Gold under stress on hawkish Fed talks ahead of CPI data

calendar 10/05/2022 - 21:23 UTC

Wall Street and Gold are both under stress on more hawkish than expected Fed talks ahead of inflation/CPI data. After the last Fed meeting on 4th May, there was a deluge of Fed speakers, essentially preparing the market/debating for bigger rate hikes as a part of the Fed’s jawboning strategy to keep prices as well as financial stability. Fed is now trying to bring down inflation expectations by ultra-hawkish jawboning. But Fed is also aiming to keep Wall Street stable by delivering lower hikes after jawboning higher.

On Friday (6th May), Fed’s Governor Waller defended the Fed's policy shift delay and argued Fed was not behind the curve, because its forward guidance on rate hikes worked from September-December’21 itself:

·         If we knew what we know today, we would have acted sooner

·         Adjustments resulted in considerably higher growth in consensus for jobs

·         The Fed received mixed signals from the labor market in August and September

·         The Fed's guidance reflected two 25 basis point rises between September and December

·         Fed guidance was seeing tightening conditions in September 2021

On Friday, St. Louis President James Bullard provided updated estimates of the degree to which the Federal Reserve is “behind the curve” on raising its policy rate in response to high inflation in the U.S. Bullard highlighted two interpretations of “behind the curve,” incorporating more recent data since his April 7 and April 21 presentations on this topic.

In the first interpretation, he used the latest Dallas Fed trimmed mean inflation rate—the most generous (lowest) interpretation of the persistent component of current inflation—along with other “generous assumptions” in a Taylor-type policy rule to get a minimum recommended value for the policy rate under current macroeconomic conditions. The recommended policy rate from the minimalist policy rule calculation is 3.63% (363 basis points), while the current value of the policy rate is 87.5 basis points. Thus, the current policy rate is below the minimalist recommendation by 275 basis points, Bullard said

In the second interpretation, Bullard suggested that the 2-year Treasury yield may provide a better representation of where Fed policy is likely to be in the near future, because of the forward guidance the Fed has given since the fourth quarter of 2021. The value of the 2-year Treasury yield on May 5 was 2.71%, about 90 basis points shy of the rate recommended in the first calculation, he said.

Generously defined Taylor-type monetary policy rules, even if based on a minimum interpretation of the persistent component of inflation, still recommends substantial increases in the policy rate, Bullard said. He added that the Fed is far “behind the curve” by this first interpretation. However, he noted that the first interpretation does not take into account Fed credibility or its use of forward guidance. “Credible forward guidance means market interest rates have increased substantially in advance of tangible Fed action. By this second definition of ‘behind the curve,’ the Fed is not as far behind, but it must now increase the policy rate to ratify the forward guidance previously given,” he said.

Overall, Bullard an influential Fed policymaker and a core member of Powell’s ‘jawboning team’, recommended about +3.75% neutral rate on 6th May, higher than the +3.50%, he indicated on 7th April. Bullard sounded more hawkish than expected.

On Monday (9th May), Fed’s Bostic said:

·         50 bps is a pretty aggressive move, the fed can stay at that pace

·         I don't see a need to hike by larger steps than 50 bps

·         Inflation is too high; the Fed needs to take real action

·         The Fed is going to move two maybe three times and see how the economy and inflation respond

·         By the end of 2023, I think the Fed needs to be somewhere in the neutral range, meaning between 2% and 2.5%

·         There's a lot of momentum in the US economy

·         Open to tightening into restrictive territory if needed

·         The hope is that things that are out of the Fed's control, like supply chains, start to get into better shape

·         All options are on the table at every meeting, depending on how the economy responds

·         The economy can coast on its momentum even as we hike rates

·         Do whatever it takes to keep the economy on a solid path

·         We don't know how people will react to high inflation environments. they may retrench

·         The impact of Ukraine on aggregate demand could be negative

·         Many of Ukraine’s effects are yet to be felt

·         There is still a lot of uncertainty to the downside as far as to demand

·         The pandemic has caused significant structural changes in the economy

·         Risks are two-sided, and the economy can go in a variety of directions

·         If supply chain easing continues, it should diminish upward pressure on prices

·         Supply chain challenges are starting to show signs of easing

·         I hope the recovery proceeds in a way that precariousness does not increase

·         If we start to see signs that businesses are thinking about reducing forces that would be quite meaningful

·         There is a lot of momentum in the labor market; I haven't heard that any of my contacts are close to laying workers off

·         If inflation slows, wage growth should slow also

·         Wage growth is in part a reset to catch up to past inflation

·         Businesses believe inflation pressures are not getting worse, and may even be improving

·         The objective is to get on a steady course back to 2% inflation

·         There are some recent signs that inflation is not accelerating, and that's a good thing

·         I'm looking at month-to-month changes in inflation

·         I am not taking anything off the table, 75 bps rate hikes are low probability, but if things turn, that may be needed

·         A 75-bps rate rise is not my baseline; I would say that (a 75-basis point rate hike) is a low probability outcome given what I expect will happen in the economy over the next three to four months

·         50 bps rate hikes in successive meetings are aggressive by historical standards; I don't think we need to be moving even more aggressively

·         I think we can stay at this pace and this cadence and see how the markets evolve---We are going to move a couple of times, maybe two, three times, see how the economy responds, see if inflation continues to move closer to our 2% target, then we can take a pause and see how things are going

·         Our policy rate has to respond more aggressively than historically

·         We will do all we can to avoid recession, and get a softer landing

Overall, the Atlanta Fed President Bostic, a known dove, sounded less dovish than expected as he said although +0.50% rate hikes for 2-3 times is a pretty aggressive move by historical standards, as inflation is also very high by historical standards-if accelerates further, the Fed may need +0.75% rate hikes.

Further, on Tuesday, Fed’s Williams said:

·         Really hard to estimate where the neutral rate is

·         The route is to pull down demand where the supply is

·         There's a path forward to a soft or softish landing

·         The Fed will move expeditiously in bringing the Fed funds rate back to more normal levels this year

·         Our actions will cool demand and factors contributing to supply shortages will be resolved

·         The Fed needs to be data-dependent, and adjust policy actions as circumstances warrant

·         The ongoing pandemic and war in Ukraine exacerbating near-term inflationary pressures, global economic uncertainty

·         The Fed's task is difficult, but not insurmountable to return balance, and price stability to the US economy

·         We have a sizzling hot labor market

·         Some economic rebalancing will be accomplished through increases in supply

·         I am resolutely focused on restoring price stability

·         I am confident that the Fed has the right tools to achieve our dual mandate goals

·         De-globalization will lower the neutral rate of interest in the long run

·         The more we can be predictable, the better

·         We understand that our policy has huge ramifications for the global economy

·         I don't know what the fed funds rate will be mid next year

·         The core inflation to EBB to 4% this year, should hit around 2.5% in 2023

·         A soft landing may mean below-trend GDP growth

·         A soft landing means maintaining a healthy labor market while inflation comes down

·         We could see unemployment up, but not in a significant way

·         We could see growth below trend for a while

·         I see a soft landing as a healthy jobs market with inflation easing

·         Wouldn’t define a soft landing as a 3.5% jobless rate

·         So far this year, the FOMC has raised the target range for the federal funds rate by 75 basis points, including a 50-basis-point increase announced after our meeting last week

·         In addition, the FOMC has indicated that it anticipates that ongoing increases in the target range will be appropriate

·         I expect the FOMC will move expeditiously in bringing the Federal Funds rate back to more normal levels this year

·         I do think as a base case of thinking, 50 basis point increases make sense exactly as Chair Powell laid out

·         We are removing accommodation pretty quickly---and that gives us a little space to move in something like the 50 basis point increment at the next couple of meetings

The NY Fed President Williams further said in his presentation:

"The challenge for monetary policy today is clear: to bring inflation down while maintaining a strong economy. This, of course, is at the heart of the Federal Reserve's dual mandate of price stability and maximum employment. Although the task is difficult, it is not insurmountable. We have the tools to return balance to the economy and restore price stability, and we are committed to using them.

Even before it took these actions, the FOMC communicated a path of raising the target federal funds rate and reducing the balance sheet. Those communications and subsequent actions are having a meaningful effect on broad financial conditions. For example, since the beginning of the year, both two-year Treasury yields and 30-year fixed mortgage rates have risen more than 2 percentage points. We have seen a significant tightening of financial conditions abroad as well.

Our monetary policy actions will cool the demand side of the equation. I also expect that over time, the factors contributing to supply shortages will be resolved, so that some of the rebalancings will be accomplished through increases in supply, both in the United States and around the world.

For 2022, I expect core PCE inflation to be nearly 4 percent, before falling to about 2 ½ percent next year. I expect inflation to further decline to close to our 2 percent longer-run goal in 2024. I expect the labor market and economy to continue to show strength and resilience. For 2022, I expect GDP growth to be around 2 percent and the unemployment rate to remain around its current low level.

Reducing inflation to our longer-run goal while keeping the labor market strength is the challenge of our time. The ongoing pandemic and war in Ukraine bring a tremendous amount of complexity and uncertainty. We will need to be data-dependent and adjust our policy actions as circumstances warrant. We have the right tools, and we will use them to meet this challenge."

Overall Williams, an influential member of Powell’s inner team, reiterated Powell’s assurances about +0.50% rate hikes in June and July and almost downplayed any possibility of a bigger move like +0.75%. Thus Williams sounded less hawkish as expected.

On Tuesday, Fed’s Mester said:

·         We're striving for a long-term goal of 2%, it will take some time to get there

·         I am optimistic there are good scenarios, but the road ahead will be bumpy

·         We might get another quarter of negative growth

·         There is good growth momentum in the economy and demand is strong

·         We'll have to wait and see how the economy plays out in the second half of the year

·         I think we'll have to move above neutral given inflation, but it is not clear how far

·         To make sure labor markets are healthy, we must control prices

·         The Fed's task is not going to be smooth; unemployment may have to rise to bring down inflation

·         We can boost the policy rate and reduce surplus demand

·         In the second half, we may have to speed up if inflation is not easing

·         I don't want to rule anything out on rate increases for the second half of the year

·         We do need to be committed and resolute in curbing inflation

·         We aim to use tools to get demand in better alignment with supply

·         The pace we are going right now seems about right

·         We are not ruling out a 75 basis point hike indefinitely

·         I don't expect inflation to move to 2% by the end of 2022 or 2023

·         There are upward risks to inflation; it won't get to 2% before 2024

·         The longer it stays at that level, the bigger the risk inflation expectations will move up

·         If price (inflation) expectations rise, it becomes much more difficult to control

·         Financial market plumbing is working

·         There will be volatility as the Fed raises rates. However, this will not change the focus on our goal

·         I expect that PCE inflation will return to roughly 2.5% in 2023

·         After half-point increases in June and July, the Fed will have to see what more is needed based on the data in the meantime

·         I would need to see monthly (inflation) numbers coming down in a compelling way before I would want to conclude we could now rest

·         The Fed MBS sales could mean market losses for the central bank

·         Losses would mean a lower Fed remittance to the treasury; though pose no operational problems for the Fed itself

·         Losses would also be a communications challenge for the Fed to explain why the benefits of a smaller balance sheet are worth it

·         Sales would help return the balance sheet to primary treasuries but could mean realizing losses depending on the interest rates at the time

·         The final size of the balance sheet will be determined by monitoring market developments as Fed holdings decline

·         I am optimistic there are still some good scenarios out there, but we have to do it. It won't be smooth, it will be bumpy and we'll have to accept those bumps along the road but be resolute in aiming for getting this inflation down

·         That doesn't change our focus on our long term goals of maximum employment and price stability

·         Between the Ukraine war, continued coronavirus lockdowns in China, and other factors the risks to inflation are skewed to the upside and the cost of allowing that inflation to continue is high

·         I think 50 (basis-point hikes) in the next two meetings makes perfect sense. It may very well be that the unemployment rate will have to move up a little bit, we may get another quarter of negative or slow growth, but that's going to have to happen if we want to get inflation down

·         I do not believe there is a tradeoff between the Fed's two goals of 2% inflation and full employment because I fundamentally believe that if we don't get back to price stability, we're not going to have sustainably healthy labor markets in the future

Overall, the Cleveland Fed President Mester, a known dove, sounded less dovish than expected as she also kept open the ‘nuclear option’ of +0.75% rate hikes to go above neutral.

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Fed will not engineer Volcker like the recession of the 1970s by abnormal rate hikes

On Tuesday, Wall Street, and Gold plunged amid hawkish Fed talks, especially after Mester said:We are not ruling out a 75 basis point hike indefinitely”. But soon after that both Wall Street and Gold recovered after Fed’s Waller said: “This is not a shock and awe Volcker moment-- erratic and surprising monetary policy doesn't serve the economy well.”

On Tuesday, the Fed Governor Waller assured that the FOMC wouldn’t make the same mistakes on inflation that it did in the 1970s. Waller said during the 1970s, the Fed talked tough on inflation but blinks every time due to White House pressure as tighter monetary policy caused an uptick in unemployment. But this time Fed will follow through on its forward guidance to raise rates until inflation comes down to Fed’s targeted/comfort level because now there is no such political pressure (at least publicly).

While Waller drew the comparison to the Fed of the 1970s and early ’80s, which eventually beat inflation with a series of huge interest rate hikes when Chairman Paul Volcker took over. Waller said:I do not think the current policymakers need to be as aggressive. They had zero credibility. I’ve got to just do this shock and awe. We don’t have that problem right now. This is not a shock-and-awe Volcker moment. We know what happened for the Fed not taking the job seriously on inflation in the 1970s, and we aren’t gonna let that happen”.

As a recapitulation, the Volcker moves took the Fed’s benchmark interest rate to close to 20% and sent the economy into recession. Waller claimed he had a conversation with the former Fed Chair before his death, and Volcker said, “If I had known what was going to happen, I never would have done it.”

Waller said he thinks the economy can withstand the path of rate hikes this time that will be much gentler than the Volcker era, while the economy is much stronger: “The labor market is strong. The economy is doing so well. This is the time to hit it if you think there’s going to be any kind of negative reaction because the economy can take it.”

Further, on Tuesday, the Richmond Fed President Barkin said the Fed doesn’t need to engineer a ‘Volcker-style recession’ to get inflation under control. Describing present elevated inflation as a result of higher demand and lower supply, Barkin said it will eventually come into balance in the medium term amid Fed tightening, which will slow demand and supply chain disruption resolution.

Barkin said in a presentation: Why We Care About Inflation          

“----everyone hates inflation.

So, we need to get inflation under control. Congress has given us this mandate. And it’s time.

We can’t do much about short-term price surges----

But in the medium term, our moves matter. So, we have begun a tightening process. We raised interest rates 25 basis points in March and then another 50 basis points in May. We also announced our plans to reduce our balance sheet, starting on June 1. During his press conference, Chair Powell noted that additional 50 basis point increases could be on the table in coming meetings as we work to normalize rates.

We will do what we need to do to contain inflation. But how exactly will our rate moves do that? I see inflation coming down two paths. A number of these pandemic-era pressures will eventually settle. Chips will finally get into cars, and car prices will come down. Labor force participation will continue to rise as COVID-19 eases. Ports will open up as consumers rotate back from goods to services. At the same time, interest rates will impact demand and expectations. Borrowing rates have already risen, and that will affect investment levels and spending on interest-sensitive items like houses and cars. And, as we act, we send messages to consumers and firms that will manage their expectations for future inflation. All of this will take a little time, but make no mistake, we are on the case.

You might ask if this path requires a Volcker-like recession. Not necessarily. At 83 basis points, we are still far from the level of interest rates that constrains the economy; for my colleagues on the FOMC, this neutral rate is in the range of 2-3 percent. And before the Great Recession, the economy handled rates even higher than that. Once we get in the range of the neutral rate, we can then determine whether inflation remains at a level that requires us to put the brakes on the economy or not.

Inflation is high. It has real costs to both individuals and businesses. By contrast, getting inflation closer to the target rate creates the certainty that enables growth and supports maximum employment. That’s why we care, and that’s why we are tackling it."


On late Tuesday, Wall Street and Gold recovered from a 75 bps hike panic low after Fed’s Waller and Barkin assured Fed will not engineer a ‘Volcker like recession’ as this is not a  ‘shock-and-awe Volcker moment’ and there is no political pressure on Fed to normalize policy and bring inflation under control.

Overall, Fed will go for +0.50% rate hikes in June and July along with $47.5B/M QT from June-August. If there is no surprise upside in sequential core PCE inflation reading, Fed will hike normal @+0.25% in September, November, and December. Thus combining all these probabilities, Fed may cumulatively hike to +2.75% by Dec’22. But if inflation accelerates further, then-Fed may also keep hiking by +0.50% or even +0.75% in September, November and December. All focus now may be on April CPI, core CPI numbers on Thursday, especially sequential growth-whether inflation is really peaking/easing/flattening or further accelerating.

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