The bond gang has gotten on its horses and is galloping madly into the fields

Outlook: Now that the bond gang has gotten on its horses and is galloping madly into the fields, the only important data is going to be today’s price deflator embedded in the GDP report and tomorrow’s PCE core price index. Before the Dec 13 meeting, the Board will also have the latest nonfarm payrolls, among other data.

Some may imagine the Fed is hinting at a shift in guidance. But no. While each Fed Gov is free to speak his mind and there is no party line, it’s possible Waller let a cat out of the bag. The cat is the Phillips curve that is roughly interpreted to mean inflation cannot be tamed without rising, and high unemployment. We noted at least one other instance in which this assumed relationship was dissed by the Fed, and here it is again.

The CME FedWatch tool shows late yesterday that for the Dec 18, 2024 meeting, or 12 ½ months from now, the biggest number of Fed funds bettors is 30.2% and they see rates down a full 1% to 4.25-4.5%. Add to that another 25% who see 4-4.25%, or 125 bp worth of cuts, then 11.3% who see 3.75-4.0%, and a wild and woolly 2% who see 3.50-3.75%.

Only 0.2% see rates at the same 5.25-5.50% as now, and 1.8% see one crummy 25 bp cut by Dec ’24. In other words, nearly every player expects cuts. 

Presumably those betting on a big set of cuts are expecting a hard landing. Fund manager Ackman told the press yesterday that’s what he sees and accordingly, the Fed may start cutting as soon as the first quarter. “It’s an out-of-consensus call: traders are fully pricing in a rate cut in June,” according to Bloomberg. Note that Waller explicitly denied the hard landing theory. 

Recession any time soon is not in the cards, and we get the second estimate of Q3 GDP today to underline that. The forecast is for a tick up to 5%. We also get the

Beige Book and talks from Cleveland Fed Mester and Richmond Fed Barkin.

In the end, the thing that counts the most is the PCE price deflator embedded in the GDP report. It’s not likely that European inflation, employment and retail sales tomorrow will get much attention if today we get a sizeable rise in GDP and any PCE drop at all. 

This means, probably, an excessive move on the same trajectory that steepened yesterday. We say “excessive” because moves of historic proportions like this one are hardly ever long-lasting. For one thing, incoming data may contradict the narrative. For another, excessive moves promote profit-taking and position paring as well as second thoughts when players see how much money is in the pot. 

Forecast: We were taken by surprise by the giant drop in the 10-year and credit/blame lies right at the feet of Fed Gov Waller. We do sometimes get big responses to Fed comments, but this one is right up there in the championship league.

We had expected a stalemate and a spate of range-trading instead of a further push in the same direction. And when the dollar is this oversold, we are at risk of a short squeeze simply because the Big Boys need to rein themselves in and pare positions, setting off a stampede in the other direction.

And this sometimes happens just because futures roll over from Dec to Mar and force everyone to zero out positions, even if they restore the same positions right afterwards. This time the Dec contract expires on Dec 18 and traders will be closing out Dec contracts about Dec 13, which coincides with the FOMC meeting.  

Then we get the “yeah, but” thinking that confuses everyone (and leads to silly posts). Example:  Europe is showing some cracks in the foundation—viz, the IFO and GfK indices, perhaps de-industrialization. Yeah, but maybe that’s just Germany.

The US economy is rip-roaring (consumer spending). Yeah, but dig that crazy government deficit that is barely disguised by the Treasury pushing the issuance into the short end. Yeah, but they got away with it. The Fed is likely to cut and maybe early next year and by a lot by year-end, hence the softish dollar. Yeah, but this is not what the Fed chief Powell is actually saying. He speaks of being careful and cautious. Yeah, but the market doesn’t believe the Fed.

The US economy is rip-roaring so that inflation could easily spike up again, and at the same time, the US is over-indebted and not fixing it. The simple solution is to keep rates high and defer rate cuts. There is some level of relatively high rates that offers support to the dollar. Yeah, but inflation spikes mean a devaluing dollar and that is, after all, good for the balance of trade, which in the long run does affect currency prices.

This is the old problem of holding two contradictory things in your head at the same time and avoiding going mad. We resolve such issues by placing weights on each factor in a set of plus and minus columns.  Here’s the problem: the darn things change, sometimes precipitously. That’s why we got shoved hard in one direction yesterday and can’t see what gets us out of it, unless PCE prices are scary high. Yeah, but Goolsbee said it’s the fastest drop in 70 years.

Bottom line, trends do not last forever. They move in cycles and waves. This dollar shorting is getting long in the tooth. Watch out.

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This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

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