On Wednesday, twas John Williams chance
To help explain, though at first glance
Inflation is sinking
No Kool-aid, he’s drinking
So, at cuts, he still looks askance

And backing him up in this view
Was Retail Sales, which really grew
There’s no indication
That US inflation
Is going to fall down near two

The pushback by FOMC speakers continued yesterday as NY Fed president Williams was the latest to explain that although things were heading in the right direction, the committee was unlikely to cut rates anywhere nearly as quickly as the market is pricing.  Here are the money lines, “My base case is that the current restrictive stance of monetary policy will continue to restore balance and bring inflation back to our 2 percent longer-run goal. I expect that we will need to maintain a restrictive stance of policy for some time to fully achieve our goals, and it will only be appropriate to dial back the degree of policy restraint when we are confident that inflation is moving toward 2 percent on a sustained basis.” [Emphasis added]. Once again, the idea that the Fed is going to cut rates in March seems awfully remote, at least based on what they are telling us.

Now, it is entirely possible that the data starts to deteriorate more rapidly with growth clearly falling and Unemployment starting to rise more rapidly and if that were to occur, I think a March cut would not be impossible.  But then yesterday we saw a much better than expected Retail Sales print, (headline +0.6%, ex autos +0.4%) with the Y/Y growth up to 5.6% (nominal).  Data like that is not indicative of a collapse in economic activity.  The fact that much of it is reliant on a combination of massive fiscal stimulus and increased credit card debt does not mean the growth is false.  It merely sets up for weakness later.

In the end, the Fed funds futures market is backing away a bit further from that March rate cut with the probability reduced to 61% now from 70% just a week ago.  It can be no surprise that between the Williams comments and the stronger data, Treasury yields backed up 5bps and equity markets suffered a bit more, down about -0.5%.

To me, the key question is, at what point will the market accept that 6 rate cuts are not the most likely outcome this year?  Clearly, they are not ready to do so yet, although based on the equity market performance so far this year, there is a little bit of nervousness, at least, making its way through the investment community.  Analyzing the price action over the past month and considering the information that we have gotten since the last FOMC meeting, the outlier seems to be Powell’s dovishness at the press conference, not the macroeconomic data nor the commentary from other Fed speakers.  Of course, Powell’s voice is clearly the most important, but when both Waller and Williams, his two top lieutenants, reiterate that maintaining restrictive policy is the right move for now, I have to believe that the next FOMC statement is going to reiterate that stance.

What does all this say about the future?  Well, since everything is data dependent, or at least that’s what they tell us, then we need to continue to watch the data to help understand the reaction function.  The problem is that there is no consistency in the data.  For instance, in addition to yesterday’s strong Retail Sales data, we saw stronger than expected NFP and higher than expected CPI readings, all three being critical real data points.  On the flip side, we have seen weaker than expected ISM data, both manufacturing and services and Tuesday’s Empire State Manufacturing Index fell to -43.7, a level only exceeded by the Covid readings in early 2020.  In fact, that index has fallen more than 50 points in the past two months.  The upshot is that we continue to see negative survey data and solid real data.  So, I ask you, which set of data is the Fed watching more closely?

FWIW my assessment of the situation is as follows: the Fed is aware of the goldilocks narrative but has not bought into it at this stage, at least not Powell and his two key lieutenants, and they are the ones that matter. Whatever the survey data, if the hard data holds up, they are going to maintain policy right where it is.  While we know they care about surveys (look at their focus on inflation expectations), I think Powell is still very afraid of being Arthur Burns redux.  Right now, it looks like the outlier was the Powell press conference, not all the push back.  I changed my entire thesis based on that pivot and that may have been a mistake.  However, if we start to see weaker hard data, so Housing softens, PCE is soft, GDP misses expectations or something like that, look for goldilocks to make a return.  Otherwise, regardless of the survey data, I fear risk assets are going to have trouble as are bond markets which have priced in a lot of rate cuts.

Speaking of push back, we continue to hear ECB speakers on the same page as the Fed, rate cuts are not coming on the market’s current timeline.  June seems to be the earliest it will happen there unless the Fed cuts sooner.  I continue to believe given the very weak growth profile in Europe that Madame Lagarde is quite anxious to get started cutting rates, but she knows she cannot do so yet.  I imagine that Interpol will have an APB out on goldilocks pretty soon as they want to capture her and keep her in the public’s eye.

One other thing to mention away from the financial markets is what appears to be a further escalation of fighting in the Middle East.  Last night, Pakistan retaliated against Iran with missile strikes of their own, ostensibly killing Pakistani militants who were based in Iran.  Whatever the rationale may be for these moves, the one truism is that things in the Middle East are getting more dangerous and that is going to pressure oil prices higher.  We have seen that this morning, with small gains, but I would suggest that will be the direction of travel if this keeps up.

Ok, on to markets where yesterday’s lackluster US equity performance was largely ignored as Japanese stocks were just barely lower, Chinese and Hong Kong stocks finally rebounded a bit and the rest of APAC saw more gainers than losers.  European markets are firmer this morning, in what could well be a trading bounce as there was no data to encourage the process and US futures are firmer at this hour (7:30) by about 0.5%.

After yesterday’s continuation bounce in yields, this morning we are seeing a bit of a pullback with Treasury and most European sovereign yields lower by about 2bps.  The one outlier is Japan, where JGB yields picked up 3bps, although that could well be a delayed response to yesterday’s Treasury price action as the Japanese data overnight was quite soft (Machinery Orders and IP both falling in November) and not indicative of tighter policy in the future.

Aside from oil’s modest gains, gold has rebounded a bit this morning, up 0.5%, arguably on the increased tensions in Iran/Pakistan but the base metals are under pressure today.  Lately, it is very difficult to glean much information from the base metals as confusion over whether Chinese growth is real, and how overall growth is progressing seems to be keeping traders on the sidelines.

Finally, the dollar is backing off its highs from yesterday, but the movement has not been large, about 0.2% broadly across both G10 and EMG currencies.  The most noteworthy outlier is ZAR, where the rand has rallied 0.85% on the back of that gold strength.

On the data front today, Housing Starts (exp 1.48M), Building Permits (1.426M), Initial Claims (207K), Continuing Claims (1845K) and Philly Fed (-7) all show up at 8:30.  As well, Atlanta Fed president Raphael Bostic speaks twice today, early and late, so it will be very interesting to hear if he is going to push back further on the Powell pivot or agree with it.

Today brings both hard and survey data, so if it all lines up one way or the other, perhaps it will be a driver.  But my take is we will continue to see a mixed picture and so will be highly reliant on Fedspeak as after Bostic today, we get Daly and Barr tomorrow and then the quiet period.  I think a risk rebound is in order just because things have been weak.  But I am worried about the longer-term trend now that Powell is seeming more and more like the outlier, not the driver.

Good luck
Adf