Put your money on 50 basis points

A WSJ article has changed market expectations…the importance of forward Fed guidance…growing uncertainty about tomorrow…don’t miss the big picture

The drama surrounding the size of tomorrow’s interest rate cut has exploded over the past week.

What was a relative sure thing just a few days ago has been turned upside down and the potential for increased volatility tomorrow has increased.

Let’s unpack this soap opera that unfolds…

About a week ago, the market was betting big on just a quarter-point interest rate cut from the Federal Reserve at tomorrow’s September FOMC meeting.

The problem was almost solved. According to the CME Group’s FedWatch tool, earlier this month, the probability of a cut of just one quarter point was 85%.

So why — just a little later, following two inflation reports that were, if anything, hotter than expected — is the market now pricing in a 63% chance of a 50 basis point cut?

Because of Nick Timiraos.

Now, you’re probably scratching your head right now. Who is Nick Timiraos?

Let’s go back to a Digest from September of last year, where we featured analysis from our hypergrowth expert Luke Lango. He meant one Wall Street Journal The article (WSJ) and its significance in relation to future Federal Reserve policy:

From Luke:

The WSJ article was important for one reason in particular. It was written by Nick Timiraos – the so-called “Fed Whisperer”; almost everything that is written about the Fed turns out to be true…

And when I talked to Luke in this research Digesthe told me:

When Timiraos is a hawk, Powell is a hawk. When Timiraos is dovish, Powell is dovish. By design.

That brings us to last Thursday’s WSJ article from Timiraos, titled “The Fed’s Rate Cut Dilemma: Start Big or Small?”

Did Timiraos intentionally let the cat out of the bag?

Let’s go to Timiraos WSJ article. And remember, going into this article, the question of the size of the interest rate cut was largely settled in the minds of Wall Street traders:

Federal Reserve Chairman Jerome Powell faces a tough decision as the central bank prepares to cut interest rates next week: Start small or go big?

The central bank is set to cut interest rates for the first time since 2020 at its meeting on September 17-18. As officials have signaled greater confidence that they can cut rates more in the next few months, they face questions about whether to cut by the traditional 0.25 percentage point or a larger 0.5 point…

Alternatively, officials may conclude that if they expect a 50 basis point move to be likely in November or December, they should make that move now, when rates are furthest from their final destination…

(A fellow at Johns Hopkins University’s Center for Financial Economics) said he thinks the Fed could manage concerns about spooking investors with a bigger cut by providing “a lot of language around it that’s not scary.” . He added: “It shouldn’t be a sign of concern.”

Now, while we highlighted some of the content that suggested a 50 basis point cut, Timiraos also offered 25 basis points of strength. But that’s the thing – he hit the fence… by a small margin to 50.

Here’s how he ended his article:

“We’re at a point where you could say, ‘I could go either way—25 or 50,’ but I think risk management has moved into the labor market and favors 50,” (Donald Kohn, former Fed vice chairman). ) said.

And just like that, Timiraos (or Powell?) threw the proverbial grenade into the mix.

Could the Fed have done a better job of signaling?

The Federal Reserve does not like to surprise the market. Therefore, he usually goes out of his way to signal his future policy moves.

It does this through “forward guidance,” which can be accomplished through official FOMC policy statements or through favored members of the media such as Timiraos.

In any case, here’s former Federal Reserve Chairman Ben Bernanke from 2013 talking about the link between Fed guidance and investor behavior and its critical importance:

Public expectations about future monetary policy actions matter today because those expectations have important effects on current financial conditions, which in turn affect output, employment, and inflation over time.

For example, because investors can freely choose between holding a long-term security or rolling a sequence of short-term securities, today’s long-term interest rates are closely related to market participants’ expectations about how rates will evolve short term…

In short, for monetary policy, expectations matter. Indeed, expectations matter so much that a central bank may be able to help make policy more effective by working to shape those expectations.

The guidance is intended to reduce excessive market volatility and confusion, not increase it. But that’s not what just happened.

Various analysts scratched and scowled at the impact of this “breaking” article. For example, here’s analyst Jim Bianco from a LinkedIn post:

Timiraos is considered the spokesperson of the federal. Instead of clarifying, what is the purpose of his stories, he took us from 14% to 50%, the maximum point of uncertainty.

In other words, the federal spokesperson in an era of forward guidance has done the opposite of providing clarity…

From the Fed’s perspective, Friday’s close in Fed futures was the worst possible: 49% chance of a 50bps cut/51% chance of a 25bps cut (chart). This is literally one tick away from maximum uncertainty (50/50).

About half of Wall Street will be disappointed/surprised if this holds through Wednesday.

The Fed designed forward guidance (tell them what’s going to happen before they do it) to prevent this exact scenario.

In the comments below Bianco’s post, the conversation became lively. A reader wrote:

Since when is the Fed’s mandate to please or not surprise Wall Street? Forward guidance should be dead…

Bianco replied:

Forward guidance should not be dead. This should be the guiding principle.

Now, if they want to end tutoring, I have no problem with that. But you don’t do it with a random story with Nick Timiraos on a Thursday morning, a week before the date, when no one is expecting it.

Because of the sudden confusion, Bianco suggested we’d get a clarifying story last Monday from Timiraos that would clear things up. Well, Bianco was wrong – the article came out this morning… but it didn’t remove the uncertainty.

Once again, Timiraos danced on both sides of the issue. But in my view, he didn’t write anything that would forcefully drive expectations back to just 25 basis points.

What I found most interesting was how much gray area Timiraos left. Here are some examples:

• Because this week’s decision is a close call, Powell could face at least one dissent from the decision of the 12 policymakers — five reserve bank presidents and seven Washington-based governors — who vote on policy…
• That this week’s decision is a close call may reflect honest uncertainty about the right choice…
• “You’ve got a bunch of people who are really unsure what the right thing is to do here,” he said. “Ultimately, Powell can probably build a reasonable consensus around each.”

Timraos might be the Fed’s spokesman, but he’s a pretty stuffy one this time.

Regardless of the forward guidance debate, what is clear is that share prices moved higher following last week’s Timiraos article.

The Nasdaq added nearly 2 percent last Thursday and Friday as expectations for a 50-basis-point cut grew. And earlier today, it’s up almost another 1% (although pulling back as I write this early afternoon). So whether Powell meant it or not, many traders are now looking for (and are positioned for) a 50 basis point cut.

Of course, if Powell pulls through, what signal will that have about the health of our economy? Why is 50 basis points necessary if everything is a hunky dory and we are about to enjoy a soft landing?

You’d expect Powell to offer an abundance of flowery hedge language in the press conference to discuss such questions.

But if Powell gives us just 25 basis points after winking and nodding to 50 through Timiraos, what was that all about? About a week ago this was not a problem. Wall Street had accepted 25 basis points. So why throw the grenade if it wasn’t going to be tracked?

Here’s the latest meme about the sudden market repositioning based on this, comparing Powell to the ignorant and simple-minded Ralph Wiggum of The Simpsons…

Source: Trend Spider

So how will this play out?

If I were on a friendly bet, I’d bet on a 50 basis point discount followed by some selling. To be clear, I’m not sure how much of this selling would come from simple “sell the news” profit-taking versus legitimate surprise at politics.

Conclusion: Given the close relationship between Powell and Timiraos, WSJ the story was no fluke, nor was the follow-up article this morning that didn’t push expectations back 25 basis points.

Powell knows that if it doesn’t reach 50, Wall Street traders will have good reason to be dismayed.

Regardless of the size of tomorrow’s cut and whatever volatility it might bring, let’s remember the big picture

Rate cuts are good for stocks…if we can avoid a recession in the next 12 months.

The following graph shows the binary…

The median 12-month market return when we avoid a recession is about 10%. But if we have a recession, the average 12-month return is a loss of about 15%.

Source: Goldman Sachs

In the meantime, keep in mind that the whole world is on its way to more discounts. In fact, get ready for the biggest global rate cut cycle since covid.

Six out of 10 of the world’s major central banks have cut interest rates this year, with more cuts to come.

Source: LSEG / Reuters / Sumanta Sen

History suggests this should be good for your portfolio over the long term.

As for the shorter term, well, get your popcorn ready. We have great drama unfolding thanks to Powell and Timiraos.

Have a good evening,

Jeff Remsburg