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These are the best of days for armchair US rate-setters.
Wednesday’s conclusion of the September monetary policy decision meeting leaves the Federal Reserve open to criticism from all sides. That it will cut rates is in no serious doubt — it has laid the groundwork for its first chop since the pandemic very thoroughly. But whether it will go for the typical quarter-point chop or by a half percentage point is a topic of heated debate across investment firms, trading floors and the nerdier corners of newsrooms.
“The obsession has been like it’s the end of the world,” said Salman Ahmed, head of macro and strategic asset allocation at investment house Fidelity. “It feels like the market is putting pressure on the Fed.”
The case for a quarter-point cut from the prevailing 5.25 per cent to 5.5 per cent target range is pretty simple. Inflation has sunk back towards the Fed’s target, the jobs market is cooling but not imploding, so it is time to take the brakes off just a little, by the usual increment.
Team “go large” points out that Fed chief Jay Powell himself opened the door to a debate about the size of rate cuts back in the summer, when he talked about the “pace” of easing at the Jackson Hole symposium. Much more recently, very serious people, such as the New York Fed’s former president Bill Dudley, have laid out the case for a half-point cut. Rates traders have taken note and shifted hard from a nailed-on expectation for a small cut, to a decent chance of a large one.
The danger for the Fed here is the risk of looking panicked. On paper, going large suggests rate setters fear they are too late to prevent a recession from taking hold, that they suspect they have messed up in keeping interest rates at their highest point in decades for so long, and they need to backtrack fast.
This time around, though, markets have taken the notion of such a big chop in their stride. If it won’t give the markets a fright, why not open with a bang?
The collective wisdom of markets does seem to be trying to force the Fed’s hand. A double chop, especially as the first move in an easing cycle, typically says that investors believe a recession is coming, particularly given that rates markets are pointing to further extensive cuts next year.
But surveys suggest investors do not believe that at all. They are either bluffing on this point or, more charitably, hedging for adverse scenarios. Bank of America’s regular survey of fund managers this week showed that only 11 per cent of investors believe the US economy is heading for a hard landing. Fully 79 per cent still expect a gentler slowdown. Once again, rates markets are showing their excitability.
The immediate challenge to markets, then, is centred on Powell’s powers of communication, which will be tested hard in the back-and-forth of the post-meeting press conference.
Would it be a nervous half-point cut to ward off disaster, or a jubilant half-point cut that declares victory over inflation? Would a quarter suggest the central bank is still afraid of inflation, too stubborn to be bold? The online army of perma-critics of the Fed is cracking its knuckles in anticipation.
The risk of violent market moves here is high. A clutch of run-to-the-hills shocks over this summer has highlighted “hypersensitive” market conditions, as a report from the Bank for International Settlements — a brains trust for big central banks — put it this week.
But all this excitement obscures an important broader point about a shift in the global pecking order of assets. Typically, the Fed sets the tone for monetary policy globally. Now, though, we have a US economy that is slowing — not crashing but slowing — to perform more in line with global peers. “An important theme is fading US exceptionalism,” said Sam Lynton-Brown, global head of macro strategy at French bank BNP Paribas. “What that means is the degree to which the US’s [bond] yields are above its peers, growth is above its peers and US assets outperform peers are likely to reduce.”
It is also a distraction — a fun one but a distraction nonetheless — away from the debate about where the bottom is for rates, and away from much more pressing issues. “Once you get past the Fed, it’s going to be election risk, recession risk, or, lest we forget, inflation could come back,” said Ahmed at Fidelity.
The stakes then will put today’s breathless speculation over the narcissism of small differences in the shade.
