Recent data point to a cooling in US consumer spending, inflation and the labor market, consistent with and paving the way for the Federal Reserve’s desired soft landing.
The key question now revolves around the timing of policy adjustments, raising concerns about whether the central bank will act too soon or too late in response to these economic developments.
If core inflation continues to fall, it’ll be a challenge for the Fed to square the circle between encouraging two-way policy risks and consistent messaging from officials (like Waller on Tuesday) about cuts to prevent the real federal funds rate from rising mechanically and telegraphing anything but multiple cuts throughout the year. There’s too much cognitive dissonance there, and the market won‘t tolerate it, especially when Fedspeakers explicitly nod to insurance cuts in public remarks.
Contrary to the musings of terminal bloggers, I see no reason for the market to scale back expectations for 100bps cuts in 2024. Two insurance cuts to keep up with falling inflation will get you halfway there, and that doesn’t count cuts aimed at short-circuiting emerging risks in the labor market or any kind of insurance the Fed might take out in the event of exogenous shocks.
Of course, Powell’s speech tonight is likely to be peppered with the pretense of two-way policy risk. However, I would seriously doubt that the market will bite.
That said, the market’s dovish tilt in November may have contributed to some overshooting in asset prices, and this is where a small dose of financial conditions reflexivity comes in. Yields are shifting slightly higher until the next set of US data confirms that more can board the Fed’s lower glide path.
