Fed's Powell did not suggest rate reduction cycle is starting, says One Point BFG’s Boockvar

Key Concepts:

• Rate cuts: Reduction in the federal funds rate by the Federal Reserve (the Fed).
• Fed minutes: Detailed record of the Federal Open Market Committee (FOMC) meetings.
• Hawkish: Monetary policy stance favoring higher interest rates to combat inflation.
• Dovish: Monetary policy stance favoring lower interest rates to stimulate economic growth.
• Neutral rate: The theoretical federal funds rate that is neither stimulative nor contractionary.
• Core PCE: Personal Consumption Expenditures Price Index excluding food and energy prices, a key inflation measure.
• Positioning: The aggregate investment strategies and exposures of market participants.
• Rate Tweaking Cycle: A period where the Fed makes small adjustments to interest rates.
• Dot Plot: A chart summarizing individual FOMC members' projections for the federal funds rate.

1. Market Reaction to Fed News and Rate Cut Expectations

• The market has been "trained" to rally when the Fed signals interest rate cuts.
• Rate cuts have been priced in for months, with Goldman Sachs projecting three rate cuts.
• The market's positive reaction was unexpected given widespread expectations of rate cuts.
• Positioning played a role, as the market was down for 5-6 days prior to the Fed announcement.
• The probability of a September rate cut had decreased to 66% before the speech, down from over 90% a few weeks prior.
• Powell's speech was interpreted as a confirmation of rate cuts in September.

2. Historical Context and Rate Cut Scenarios

• Historically, the Fed cuts rates by 180 basis points in non-recessionary periods and 400 basis points in recessionary periods.
• The question is whether the anticipated rate cuts will be a one-off event or part of a larger trend.

3. The Neutral Rate and Inflation

• The neutral rate is only truly neutral when inflation is sustainably at 2%.
• If inflation is at 3%, a 3% nominal rate is not neutral.
• According to the Fed's dot plot, the neutral rate is 1% when inflation is at 2%.
• If core PCE confirms inflation at 2.9% on Thursday, the Fed funds rate should technically be at 3.9%.
• One or two rate cuts would bring the rate close to the neutral level.

4. Contradictory Signals from the Fed

• The Fed minutes from a meeting a couple of weeks prior were "fairly hawkish."
• Powell's speech three and a half weeks prior did not hint at any changes.
• The minutes indicated that "several many most" members talked hawkishly within that meeting.
• The contradictory signals from the Fed minutes and Powell's speech caused confusion.

5. Rate Tweaking vs. Rate Cutting Cycle

• The speaker believes that the current situation is a "rate tweaking cycle," not a full-blown "rate cutting cycle."

6. Notable Quotes

• "The market's been trained. The stock market's been trained to rally. Whenever the fed tells you they're going to cut interest rates."
• "The market is always what have you done for me lately."

7. Synthesis/Conclusion

The market's reaction to the Fed's signals regarding potential rate cuts was complex and influenced by pre-existing positioning and expectations. While rate cuts have been anticipated, the extent and nature of these cuts remain uncertain. The Fed's own communications have been somewhat contradictory, leading to confusion among market participants. The key takeaway is that the Fed may be engaging in a "rate tweaking cycle" rather than a more aggressive rate-cutting campaign, and the neutral rate is dependent on achieving a sustainable 2% inflation rate.