Market View

Will the Fed be there for us?

Like most industries, working in finance comes with its own vernacular.

Dollar Notes
Jeremy Sterngold, Deputy Chief Investment Officer

For a lot of younger people, terms such as “inflation” and “wage price spiral” have been dusted off from the history books over the past few years. However, the lingo is not just limited to finance specific terms, but ones used more commonly that take on a different meaning in our industry. A case in point would be the use of bird species to describe central bankers as either “doves” or “hawks” in terms of their policy stance or “transitory” in terms of inflation. A term that has become more prevalent in our world of late is “pivot”.

In my younger days, that word for me was associated with an amusing memory from the popular sitcom Friends. In a specific episode, the character Ross is seen purchasing an expensive sofa and seeks to avoid paying the extortionate New York City delivery fees so opts to shlep it up the stairs with the help of his friends (pun intended). During that process, he starts shouting the word pivot over and over to get them to shift the couch.

Even though investors are pricing some further hikes, with a 0.25% increase widely expected next week, the futures market is pricing in that the Federal Reserve (Fed) will shift its stance later this year and “pivot”. The real question is whether this should be celebrated or feared.

What do we mean by pivot?

Before delving deeper, it is worth clarifying what we mean by pivot as it appears to have taken on several meanings. For some, the pivot represents the slowdown in rate increases from 0.75% in November to 0.5% in December with expectations for it to slow down further to 0.25% next Wednesday when the Fed announces its next policy decision. Other investors deem it when the Fed eventually pauses with rate hikes and keep rates steady for some time.

We would be of the view that a pivot has occurred when the Fed starts reducing interest rates. When the Fed likely pauses, it still intends to shrink its balance sheet under its Quantitative Tightening programme and as such this would represent tighter monetary policy, something implicit in the name of this process.

Why is the futures market pricing in rate cuts?

While the US economy has held up well so far given the 4.25% of cumulative rate hikes of last year, there are signs that the economy has started to lose momentum. Forward-looking survey data is showing a decline in new orders and the housing market is buckling under the weight of higher mortgage costs.

Although the strong labour market has resulted in robust wage increases, and while price pressures have moderated of late, real wages have been under pressure since April 2021. This has weighed on consumption with retail sales declining in both November and December, months that typically see stronger sales given Thanksgiving and the Christmas holidays.

Companies are sensing a change of environment which is leading to several high-profile layoffs. Therefore, in summary, it seems that the Fed has achieved its stated desire and has started to create some slack in an economy that previously appeared to run above trend. Which leaves the question: why is the Fed still set on raising rates and when is it likely to reverse course?

I’ll be there for you

In the decade prior to the pandemic, some may argue since the late 1980s, investors have become accustomed to central bankers supporting demand by cutting interest rates when the economy was facing harder times. This backdrop of implicit “I’ll be there for you” has fuelled, to a degree, a mentality of “buying the dip” in markets.

Following the breakup of the Soviet Union and bringing China into the fold, millions of workers were added to the global labour pool. This period of globalisation saw a supply side that was more responsive to changes in demand. Given the supply side shocks that central banks have witnessed over the past three years, they now must consider the supply side of the economy more acutely, with labour and energy being key factors. Failing that, they risk inflation becoming more persistent over the medium term.

Taking all of this together, this means the Fed is likely to remain stuck in a higher gear than we have been accustomed to, and this may result in the need to slam on the brakes later on. Hence, in our view, while the pivot will provide some welcome relief for borrowers, this will likely to be in response to an economy that is creating a higher degree of slack. As such, while investors may be shouting “pivot” to Fed, just like Ross did, when it comes to it, the pivot may not deliver much initial relief to markets. 


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