Can the Fed under-deliver?
Macro Perspectives
We've talked a lot about the buildup to this week's Fed decision.
This will be the first Fed meeting since July 27th, when they raised rates by 75 basis points AND told us that they had reached the "neutral level" for rates (no longer accommodative, but also not restrictive). In his July press conference, Jay Powell went further to say that they didn't want to telegraph mechanical tightening (my words, his words: they were no longer providing "guidance"). He said from that point (in July) they would go meeting by meeting, based on the data.
This was dovish-stocks went up.
Let's talk about what has happened since the Fed's July 27th meeting;
Just hours after the July Fed meeting, headlines started hitting the wires about another massive spending bill (a deal between Manchin and Schumer)-this was the Build Back Better agenda, with another name.
A day later, the House approved the Chips Act (more spending).
A month later, Biden followed with school loan forgiveness (more spending).
This was a fiscal bazooka, just after the Fed intimated that they may be done (or near done) raising rates. More fiscal spending plus less restrictive monetary policy is a formula for a growth boom but also an inflation boom (more fuel on the fire).
With that, the Fed spent the next three weeks in damage control, trying to dial down the expectations of a hotter economy and hotter prices.
As we've discussed, the Fed is far more concerned about inflation expectations than it is about inflation. If they lose control of expectations, people start pulling forward purchases in anticipation of higher prices, creating a self-fulfilling upward spiral in prices.
So, the Fed went on a media blitz. Fed officials were all over the wires, day-in and day-out, telling us just how relentless they would be in raising interest rates, "keeping at it" until the war on inflation is won, "unconditionally" focused on stabilizing prices.
It has worked. The market has bought the message the Fed is selling. The damage (i.e., consumer and business perception of a more inflationary environment coming down the line) has been controlled; stocks lost 4% in August, and the 10-year yield has gone from 2.5% to 3.5% since early August.
The question is: will the Fed deliver with actions that match the words?
They haven't to this point. Additionally, they have plenty of reasons, by sticking to the data, to under-deliver on Wednesday;
Gas prices are a dollar cheaper than in late July.
The monthly change for both July and August core CPI was roughly flat (0% and 0.1%, respectively).
This further aligns with the broad declines in the pace of price increases across the various manufacturing reports (which have been trending sharply lower for months).
Remember, the Fed is tasked with a rate-of-change, not level. The level of prices is here to stay. The rate of change in prices has already subsided.
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