Opportunism as a new rule of the game

Alexander Ovchinnikov

Sep 19, 2024

The current leadership of the Fed has 'outplayed everyone' — the situation is at an impasse. This is Jerome Powell's remarkable ability — to do what is not expected of him, and to do nothing when it is needed. I think Powell's chairmanship will go down in history, and he himself will be remembered by investors as the antithesis of Alan Greenspan, a consistent and decisive Fed leader.

A 50 bps rate cut is unique. It creates a win/win situation out of nowhere, where no one loses — and everyone wins. But it also creates new conditions in the market — anarchy. The regulator has 'left the intersection,' and from now on, market participants are forced to figure out for themselves what is important and what is not. Obviously, investors will have to independently determine what is really happening with the economy.

Now let's go through the data without emotions.

1. Every quarter, the Fed updates its economic forecasts: yesterday the GDP forecast for 2024 was lowered from 2.1% to 2.0%. We note that there is no collapse.
2. Labor market: the unemployment rate was adjusted to 4.4% against the June estimate of 4.0%. Logical, but nothing new: in July, the figure reached 4.3%, and in August, it fell to 4.2%. In other words, we are now somewhere 'in the middle of expectations.' And it is obvious that the Fed itself is not sure what might happen in the remaining three months of the year.
3. The Fed lowered its inflation forecast (i.e., the personal consumption expenditures deflator, PCE) to 2.3% against the June estimate of 2.6%. We note that this is a change, but not a collapse, for example, to 0.5%.

At the press conference, Jerome Powell stated that 'recent data indicates confident growth rates of economic activity,' and the labor market is cooling. Just cooling, not collapsing.

So what prompted the Fed to cut the rate by 50 bps?

The decision to change the rate so drastically has always been made under conditions of financial stress, but there are no signs of this. There are also no shocks: there is no collapse of systemically important financial institutions, no stock market crash like in 2018, when the Fed paused quantitative tightening (QT) and even began to lower the rate. There is no collapse in company valuations and their bankruptcies that could lead to risks of layoffs and tension in the labor market.

None of this is present. There is only an 'automatic,' technical market reaction: the cost of short-term credit has been reduced — hence, the difference between the yields of long-term and short-term bonds should increase. The corporate sector, all else being equal, receives better credit conditions — hence, the stock market investor has nothing to worry about, the market can continue to grow. But here two important questions arise. Firstly, will such a radical reduction in the Central Bank's (CB) credit rate not support price growth in the services sector, which was already not very inclined to reduce volumes and slow down prices?

Perhaps the Fed's decision was dictated by budgetary needs. But this looks like a political move before the elections. At this moment, it becomes very difficult to talk about the independence of the central bank, and therefore about the market's trust in this institution (at least until the current leadership changes).

Opportunism and unpredictability put market participants before the fact: now it is worth relying only on one's own experience and ability to correctly interpret macroeconomic data. Will the influence of market activists increase in this environment? Yes, but they were already actively influencing sentiment and even asset prices before. But now market volatility may only increase.

And finally. The rate cut will undoubtedly lead to a revaluation of short-term bills — three- and six-month ones. They simply 'technically' cannot deviate much from the CB rate. But the variability in the valuation of long-term bonds will only increase. And yesterday's market close, when the yield on ten-year Treasury bonds rose to 3.72% by the end of trading, showed this.