Authored by Simon White, Bloomberg macro strategist,
The Fed has recently upped its hawkish resolve, but by how much depends on how you look at it. Nonetheless, liquidity conditions remain very tight which will keep a lid on risk-asset performance.
How we can objectively measure how hawkish the Fed is? The peak expected rate, implied from the fed funds futures curve deflated by inflation swaps, is one way. On this measure, the real peak rate is close to its cycle-highs, and is as positive as it has been since 2009.
How hawkish is the Fed relative to the market? In most of the decade-long existence of the Fed’s Dots (where FOMC members and Fed presidents project where the Fed rate will be), the market has persistently undershot where it thinks the target rate will be versus the Fed. But in recent months, the market’s expected peak rate is often ahead of the peak Dots rate, and is as high as it has yet been, apart from two brief periods in early 2022.
The market is now doing the Fed’s work. This paradoxically will eventually curtail the central bank’s hawkishness as the market is now transmitting and intensifying Fed policy, rather than inhibiting it.
An alternative way of looking at Fed hawkishness tries to incorporate “higher for longer” (H4L). The Fed has repeatedly stated it would like to raise rates to their peak, and keep them there for an “extended” period. The market has generally disagreed, with a consistent “Fed pivot” of rate cuts priced in soon after the peak is reached.
As the peak expected rate has risen, the pace of cuts has not significantly fallen, so the market continues to push back on H4L.
The chart below captures this by looking at how many months it would take to bring the expected peak rate down to zero, if it fell at the monthly pace implied by the cuts priced in after when the rate peaks. On this measure, the Fed was closer to H4L through most of last year than it is now.
The cuts priced in over 2024 and 2025 are currently keeping monetary conditions looser than they would be if the Fed was truly able get the market to believe in H4L. Forward guidance that’s not at the zero-bound doesn’t seem to work as well.
With liquidity conditions already very tight, the Fed pushing the market into fully pricing H4L may cause more problems than it solves.
Tyler Durden
Fri, 02/17/2023 – 08:27
