YWR: Why Fed Funds is going to 6.
Usual disclosure: These are personal views. We are all adults. Do your own work.
So much Fed analysis this week.
So many smart people. So many smart views.
And yet they’re missing the big thing.
It’s happening, but no one is saying anything.
The rising dot plots are part of a gradual process to reset the market.
The Fed is going to raise rates.
Seems crazy and goes against every inflation/interest rate
indicator in the market.
But here is how it happens.
Outline:
Terminator Analog
Eaton and the Mega Projects
Pushbacks 1-3
Pushback 4
How I’m playing it
Reference material
Terminator 2 Resurrection
There is a scene at the end of Terminator 2 when the T1000 is broken into pieces and splattered on the ground after a big fight. It seems dead for sure. It must be. But Arnie, (the T800) knows not to turn his back and is still watching it. After a time the polymetallic pieces of the T1000 slowly form back together piece by piece.
Arnie knows what’s about to happen. ‘We don’t have much time’.
The T800 is Powell and he’s fighting an inflation terminator. A terminator which won’t stop.
Let’s revisit 2022.
In 2022 Powell bravely raised his shotgun and pumped five rounds into the the advancing inflation terminator. Over 18 months he took the Fed Funds rate from 0 to over 5.25%. A shocking move if you think about it.
Surely, this would do the job. It might cause a painful recession and a banking crisis, but it should stop inflation. Powell was adamant inflation was the bigger problem and the Fed would stand by its 2% target even if it required taking pain. Powell warned us he expected the unemployment rate to go up as a result of this rapid hiking cycle. The labor market was too hot and there were going to have to be job losses to get inflation back under control, even if it was unpleasant for those unemployed.
Stocks and bonds crashed in 2022 in response, and the outlook for 2023 was a recession. Remember all the recession indicators? The consensus view was an economy used to 0% rates for over a decade could not survive such a shocking and sudden change to interest rates. It would be the GFC all over again.
It would be a bloody fight, but at least the inflation terminator would be dead. The next issue would be getting the US of the recession.
Below is a slide from Jeff Gundlach’s webcast in December 2022 (full presentation in reference material at the end of the post). Jeff’s forecast was that “by the end of this year (2023) the inflation story will be over.”
During the webcast the point Jeff was making with the slide below was that he thought the 2% inflation forecast looked suspiciously straight. Why was inflation going to drop like a stone and then just stop at 2% and go sideways? Seemed weird.
Jeff’s view was that after coming off a historic surge in inflation, COVID stimulus, bottlenecks and inventory over ordering, you could have an equally symmetric move to the downside as all the stimulus dropped away. In the same way 9% to the upside was unimaginable, couldn’t there be an equally unimaginable move to the downside? Inflation could go negative. And then add in a recession too. We were going to go back into deflation and the Fed would be rapidly cutting. Much faster than the dot plots suggested.
The smartest bond investor in the world was saying to buy US 10 yr’s because inflation might go negative (full 2022 Doubleline presentation in the appendix below).
It all made perfect sense.
But that’s not how it turned out. Instead, after a historic rate rise, we are in 2024, with no recession, still trying to get inflation back to target.
Rule of thumb for Hollywood movies, boxing and central banking: If you’ve just landed your best shot and the villain is still standing there looking at you, then you have a problem.
And so that’s why I see the 3.4% CPI number differently from other analysts. The contribution from Energy and Core goods is negative yoy and yet CPI is still above 3%. That’s not a good set up.
How long is the contribution from goods and energy going to stay negative?
The T1000 might be forming back together.
Eaton and the MegaProjects
Back in January we wrote 7 Reasons Rates Go Higher.
My favourite part was the interview with Eaton CEO Craig Arnold. Craig has the best perspective on what’s happening, because he’s in the middle of all the trends no one is talking about. It’s another reason inflation isn’t falling and it’s what the macro forecasters are missing.
I encourage you to read the full interview, but here are two key points, and they are related.