Fed's Latest Surprise Will Shock Economy | Danielle DiMartino Booth

Key Concepts

• Federal Open Market Committee (FOMC): The monetary policymaking body of the Federal Reserve System.
• Policy Interest Rate: The target rate set by the FOMC for overnight lending between banks.
• Quantitative Tightening (QT): The process by which the Federal Reserve reduces the size of its balance sheet by allowing assets to mature without reinvesting the principal.
• Consumer Price Index (CPI): A measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.
• Basis Points (bps): A unit of measure used in finance to describe the smallest possible change in a financial instrument. One basis point is equal to 0.01% or 1/100th of a percent.
• Hawkish: Refers to a monetary policy stance that favors higher interest rates to combat inflation.
• Dovish: Refers to a monetary policy stance that favors lower interest rates to stimulate economic growth.
• Balance Sheet: A financial statement that summarizes a company's assets, liabilities, and shareholders' equity at a specific point in time. For the Fed, it refers to the total value of assets it holds.
• Mortgage-Backed Securities (MBS): A type of asset-backed security that is secured by a mortgage or a collection of mortgages.
• Treasuries: Debt securities issued by the U.S. Department of the Treasury.
• AI Infrastructure: The hardware and software required to support artificial intelligence applications, such as data centers and specialized computing chips.
• Wealth Effect: The tendency for people to spend more when they feel wealthier, often due to an increase in asset values like stocks or real estate.
• DXY (US Dollar Currency Index): An index that measures the value of the U.S. dollar relative to a basket of foreign currencies.
• Bond Yields: The return an investor realizes on a bond.

FOMC Decision and Market Reaction

The Federal Open Market Committee (FOMC) decided to lower its policy interest rate by a quarter percentage point (25 basis points). Additionally, the FOMC announced the conclusion of the reduction of its aggregate securities holdings as of December 1st.

Dissenting Votes and Interpretations

• Steven Moran: Advocated for a larger 50 basis point rate cut.
• Kansas City Fed President: Voted to pause rate cuts altogether. This individual's vote is notable as they are a relatively new president and their final vote is on December 10th, with a three-year rotation for regional Fed presidents (excluding the New York Fed, which has a permanent vote, and Cleveland and Chicago, which rotate every other year). The speaker speculates this may have been an attempt to be remembered as a "hawk" before a period of absence from voting.

Market Expectations and Powell's Statement

• December Rate Cut Probability: Before the meeting, the probability of a rate cut in December was over 90%. After the meeting and Chair Powell's statement, this probability dropped to 66%.
• Powell's "Not a Foregone Conclusion" Statement: This statement signals two things:
  1. The December rate cut is not guaranteed.
  2. Powell is likely to remain as Chair until at least December, as a new appointee's first action would likely be a rate cut.

Jerome Powell's Tenure and Potential Successors

• Powell's Plans: Danielle D. Martino Booth has not heard Chair Powell indicate any plans to leave when his term is up in May.
• Successor Naming: Treasury Secretary Scott Bessent aims to have Powell's successor named around Thanksgiving.
• FOMC Election: If the FOMC members choose to re-elect Powell as Chair after his current term ends in May, he could remain in that position until January 2028, regardless of who President Trump appoints as the Fed Chair.

Impact of Government Shutdown on Monetary Policy

Chair Powell acknowledged that the ongoing government shutdown makes it more difficult to make policy decisions, particularly in December.

• Reliance on Private Data: The shutdown limits the Fed's access to official government data, forcing reliance on private data and surveys, which Powell described as "driving in the fog."
• Cautionary Stance: Powell suggested this could lead to a more cautious approach to rate cuts in December, as the Fed may need to "slow down."
• Interpretation: The speaker views this as Powell potentially blaming Congress for slowing down the pace of rate cuts and using layoffs as an excuse to pressure the administration to reopen the government. The speaker argues that real economic conditions are observable without official data.

Quantitative Tightening (QT) and Balance Sheet Reduction

The Fed has been reducing its balance sheet, which stood at $9 trillion and is now around $6.6 trillion.

• End of QT: As of December 1st, the Fed will stop reducing its aggregate securities holdings.
• November's Activity: November is the last month where $5 billion of treasuries will roll off the Fed's balance sheet.
• Future Balance Sheet Management:
  • Maturing treasuries will be replaced by fresh purchases to maintain the balance sheet size.
  • If the Fed can roll off $35 billion of mortgage-backed securities (MBS) each month, they will reinvest that amount into treasuries.
• QE Concerns: The speaker anticipates that reinvesting in treasuries will be perceived as Quantitative Easing (QE).

AI Investments and Interest Rate Sensitivity

A reporter questioned whether AI investments and capital expenditures (capex) are already boosting the economy and markets, and if current rates are restrictive enough.

• AI Investment Boom: There is a significant investment in AI infrastructure, with large U.S. companies dedicating resources to understanding AI's impact.
• Interest Sensitivity: Powell believes that spending on data centers is not particularly interest-sensitive, being driven by longer-term assessments of productivity gains. He is unsure how these investments will ultimately perform but doesn't see them as highly interest-sensitive compared to other sectors.
• Inflationary Concerns: The speaker questions if adding liquidity could cause inflation.
• Booth's Perspective: Booth considers the argument that AI investments are fueling inflation "flimsy." While acknowledging the wealth effect for the top 10% due to stock market highs (e.g., Nvidia), she argues there's no significant inflationary impulse for the other 90% and a 25 basis point rate cut won't ignite inflation without purchasing power.

Impact of Rate Cuts on Income Distribution

• Powell's Statement: When asked about the impact of rate cuts on different income levels, Powell stated that typically, rate cuts have a bigger impact on the middle class and the bottom half of the income distribution.
• Booth's Observation: Booth notes that despite the Fed's anticipated rate cuts, automobile loan rates are near record highs, credit card borrowing rates have barely decreased, and mortgage rates actually increased after the Fed's announcement.

Factors Potentially Slowing Market Rally

The speaker wonders what could halt the current market rally, given the perceived "Fed pivot."

• Slowdown in Passive Inflows: A slowdown in the daily passive inflows into the market could stall the rally.
• Recession Recognition: If a recession is officially recognized, it could lead to a pullback in the stock market.
• Current Trend: Currently, "flows know," meaning money is going into the market, particularly into large-cap stocks.

Labor Market Update and Inflation Trends

• Layoffs: Layoff announcements in October are tracking to be the second highest in the last two years. Companies selling to lower and middle-income consumers (e.g., Kraft Heinz, Manderly, PayPal) are reporting reduced consumer spending due to rising essential costs (food, electricity).
• Shelter Costs: Shelter prices (home prices and rentals) are coming down.
• Overall Inflation: Generally, inflation is not considered problematic at present.

Bond Yields and Future Outlook

• Ten-Year Yields: Ten-year yields have been falling throughout the year.
• Post-FOMC Reaction: Yields soared immediately after the Fed's announcement, as traders dumped bonds.
• Bond Market's Role: Booth suggests that if the Fed ignores the real economy and refuses to lower rates, the bond market may "do the Fed's job for it" by forcing the Fed to pay attention.

Fed's Data Reliance and Political Stance

• Powell's "Driving in the Fog" Analogy: The speaker criticizes Powell's analogy, calling it "flimsy" and "political."
• Use of Private Data: Booth asserts that the Fed can use private data but chooses not to.
• Violation of Federal Reserve Act: The speaker believes the Fed's current openly political stance may be a violation of the Federal Reserve Act.
• Obligation to All Americans: The speaker argues that the Fed has an obligation to make monetary policy for the good of all Americans, not just the top 10%.

Impact on Dollar and Anti-Dollar Assets (Gold)

• Gold Prices: Gold has fallen from $4,000 to below $4,000.
• DXY: The US Dollar Currency Index (DXY) saw a significant boost today.
• Dollar Strength: Despite market anticipation of Fed rate cuts, the dollar has been quietly strengthening.
• Investor Caution: Investors are advised to be cautious about the "froth" in recent gold moves and expect continued consolidation.
• Dollar Weakening: Booth is hesitant to predict a weakening dollar, even if bond yields fall, as the bond market may act independently.

Where to Follow Danielle D. Martino Booth

• Twitter (X): @dmartbooth
• Substack: The Daily Feather dart.substack.com
• Website: qiresearch.com (for institutional investors, family offices)