Is the Fed Going to Pivot?
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Fed pivot, Fed pivot, when is the Fed pivoting? Do you think the Fed will pivot after this next tightening? Do you think the Fed will pivot due to political pressures? CPI down ticked, is the Fed going to pivot? The investment community seems infatuated with a Fed pivot.
What does a Fed pivot even mean? Does it mean that the Fed will pause further rate hikes to assess the cumulative impact upon the economy and inflation? Does it mean that the Fed will turn tail and go from tightening to easing? The market seems confused but everyone seems on guard for the elusive Fed pivot.
According to Investopedia, a Fed pivot occurs when the Federal Reserve reverses its policy outlook and changes course from expansionary (loose) to contractionary (tight) monetary policy- or, conversely, from contractionary to expansionary. Using this definition- keep dreaming. The Fed is not going to switch to an expansionary (loose) monetary policy anytime in the near-future. Barring an unforeseen systemic catastrophe to the financial system. Of course, it is entirely rational to believe that the Fed will pause and assess the impact of its rate hikes at some point in the relatively near future.
The investment community is also enamored with the terminal Fed Funds rate (the maximum level the Fed will hike Fed Funds).
Of course, the terminal rate is not necessarily actually terminal and it is merely a level from which further assessment will occur as the Fed takes inventory with respect to the rate hike impact thus far and decides the next terminal rate.
The dovish members of the FOMC put this rate at 5%. Fed’s Bullard has indicated a number as high as 7%. Powell told us in no uncertain terms that the magnitude of individual rate hikes will decline from 75 bps per hike however, the terminal rate is likely to be higher than previously anticipated. So, we have a situation where the Fed thinks the next term terminal rate is 5-7%. Guess what? They don’t know. Neither do I and neither do you.
What we know is that it’s not the current 4%. We have at least 100 bps of Fed tightening ahead before even the most dovish forecasts approach the near-term terminal rate. The Fed has guided that they will hike 50 bps at the Dec. 15-16 meeting. The Jan. 31-Feb. 1 will likely be another 50 bps. This is the minimum reasonable expectation irrespective of upcoming figures such as the CPI numbers and other economic statistics.
Beyond Feb. 1, 2023, there are 7 additional FOMC meetings next year.
Could the Fed hike 50 bps at each meeting and take Fed Funds to 8.5% by year-end 2023, yes. Could they pause for a few months to assess impact and then resume, yes. Furthermore, could they downshift to 25 bps per meeting and take Fed Funds to 6.75% by year-end 2023, yes. Could they pause at 5% and leave rates there for an extended period of time, yes. Will they lower the Fed Funds rate over any foreseeable horizon- no.
Where is the Fed pivot? I have no idea why everyone is so focused upon a Fed pivot. We have zero indication that the Fed is planning to change course anytime soon. The numbers don’t warrant it, the Fed has flat out said no, and, the Fed has bitten the bullet and worked hard in an effort to normalize rates and I doubt they are going to squander that effort unless the economy is falling apart at the seams.
Based upon the totality of facts and, acknowledging that nobody can foretell the future including the Federal Reserve, my best guess of the base case seems to be 5-6% and then a pause to assess. My base case is that the pause at 5-6% will be for an extended period of time as the Fed maintains maximum flexibility at those levels. When the Fed moves off those levels, it seems logical that there is just as much chance of rates going up as there is rates coming down from there. To think otherwise is simply guessing and maybe hoping. We simply have no facts to support anything other than a coin flip from there.
Despite this, everyone seems to be looking for the Fed pivot.
I’ve heard participants say, “we’re in the 7th inning of the Fed tightening cycle..”. Really? I’m not sure how they know that. Having traded through the NASDAQ crash of 2000-2001 and the market crash of 2007-2008. I can tell you that the entire way down people were looking for chances to buy. I never heard anyone say, I’m selling and if the market bounces, I’m selling more. The mantra of the day was, “when can we buy?”. I suppose that is human nature and it feels the same today with all the Fed pivot talk.
In any case, given the current best guess terminal rate of 5-7%, is anyone really interested to buy a US 10-year note at 3.8%?
How about a 10-year German Bund at 2.01%? No?
Is that because US CPI has recently fallen to 7.7% and German inflation is 10.4%? I suppose a negative real yield of -4% and -8% just isn’t attractive?
If you don’t want to buy them, how about enjoying this gift and selling them and forgetting about the pivot for now? That’s what I’m doing. Oh remember, the Fed is unwinding $1 Trillion per year from its balance sheet as well. Not really what I would call a bargain in the bond market.
Written by Top Ranked Global Hedge Fund Manager Neal Berger, Eagles View Capital Management
Neal was awarded a place on the list of: Top Hedge Fund Managers 2022
Is the Fed Going to Pivot?
