A Fed Preview: Setting the Stage

I was driving home from the train station in November of 2018, listening to Chairman Powell deliver a speech in front of the Dallas Fed. His tone was steady but the cracks showing about global headwinds. From there, I embarked on a journey to combine my history of trading markets, intuition toward policy and a straightforward nature toward sharing my thoughts and opinions on trading floors around the world.

Let’s take a look heading into this week’s Fed meeting breaking down the dynamics as I see them:

The 3 P’s:

Powell

Smart man. Private and public success. He was the choice of the Potus. And I believe, despite the rhetoric, he still is. Why?

Chair Powell comes from the private sector. In the moment of viewing him as we know him now as “Fed Chair”, it is easy to lose sight of his prior path.

Inherently I believe the President would be terrified to have a pure academic in that seat. He pesters him- because he relates to him. And feels comfortable in doing so.

Potus

There should be no doubt Potus wants rates lower heading into 2020. He is a stock market President. But let’s make no bones about it, the dynamics that drive markets have changed. Within this window of time, though, things still look good. The outreach for lower rates is ongoing, and despite headwinds from the tariff situation with China, equity valuations are still within reach of all-time highs. And at the same time, pricing for Fed expectations have gone his way. Good hand played so far.

Pricing:

Markets are hungry and pricing is very swift. Much, within the theme of what I presented in the last 8 months, focused on the Fed losing some control and ground; post Pivot. Markets in general are not forgiving once burned.

So, we’ve gone from the markets chasing the Fed (4 hikes in 2019) to the Fed chasing the markets (3 easings 2019). Market expectations v Fed intentions has been at the core of the discussions.

In the end, the Fed has done neither in 2019. Pricing needs to be tempered within that context, though, but the true direction of pricing matters. The force that is priced toward easing and liquidity will always outweigh that of tightening.

This week’s meeting:

This will be the Chairman’s toughest press conference. He will be questioned on a number of fronts regarding pricing, Fed independence and the economy. Let’s look:

1) Fed Independence– The Fed is in a tough spot. Imagine someone telling you repeatedly I told you so and now appears right. Powell needs to maintain independence but a softening of the Fed’s tone in likely. I expect him to repeat what is already known: the Fed will react to data and conditions, prepared to do what is necessary to support their mandate.

2) Pricing– global rates are flat to negative. The Canadian yield curve is infested with inversion. The Fed is simply too tight. There was a window to normalize which the Fed seized but give-back seems likely.

3) Economy– weakening globally. Inflation in tow. We can micro discuss the bits and pieces of tariff repercussions, but in the end Clarida himself has been vocal about an overall tax on growth. Hard to imagine Powell presents differently. It seems logical that disruption of this nature globally will be a growth detraction.

Conclusion

It is our opinion lower rates are coming from the Fed. We believe that 50-100 basis points (2019-2020) is possible. We don’t expect that all to come this year, although the direction is right and matters.

This market is hungry and swift. And if the direction is right, and matters, short end US yields will disappear given the global choices we are looking at, with a yield curve that is much steeper than today.

Pricing to a scenario versus delivery will look very different.