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Earler this week we received the latest report on inflation. In October, the Consumer Price Index (CPI) rose by 0.2% on a headline basis and 0.3% excluding food and energy. The readings were in-line with market consensus, but this was the third month in a row that the core rose by 0.3%. That annualizes to about 3.6%. The last time I checked, 3.6% was meaningfully above 2%.
Yet the prevailing view is that the Fed will cut rates once again in December. The CME FedWatch tool shows an 82% chance of another 25 basis point cut, and the IBKR ForecastTrader shows a 77% chance that rates will not be set above 4.375% at the December meeting. Then again, in an interview this morning, Minneapolis Fed President Kashkari said that “another rate cut is certainly possible” in December. Who are we to believe, the data, or a regional Fed President – even if he is currently a non-voting member of the FOMC?
I’ve been around markets too long to advocate for “fighting the tape.” If the market is convinced of an outcome, it is usually better to respect it, at least in the short term. Contrarian opinions are quite important – sometimes the market does indeed get it wrong, and it is crucial to stress-test any investment thesis – but not necessarily when it comes to an impending FOMC meeting. The Powell Fed does not like to surprise markets. So, until or unless we hear Fed talking heads pushing back on the prevailing narrative, the simplest assumption regarding is currently the most obvious one.
But is it the correct one for the economy? I’m highly skeptical of that. Last week we wrote:
My view is that the Fed needn’t have rushed to cut rates in September, nor is there a pressing need to continue cuts. Frankly, there is little real-world evidence that monetary policy is restrictive in practice. There are few, if any, signs of credit market stress, stock markets are at all-time highs, and a 4.1% unemployment rate would have been considered full employment throughout much of recent American history. Quantitative tightening (QT) has reduced the Fed’s balance sheet substantially, though it is far larger than its pre-Covid levels. And while it has reduced the market’s dependence upon reverse repos, it is not as though QT is causing any particular stress
I consume quite a bit of financial media and I’ve yet to hear anyone complain that monetary conditions are preventing them from doing anything they wanted to. They’re not preventing bitcoin’s price from going vertical. During their most recent earnings reports, major investment banks crowed about their investment banking revenues, meaning that corporate borrowers were able to raise money without concern. And not only are major stock indices at or near record highs, seemingly every day there is some oddball name with a triple-digit rise thanks to a relatively minor piece of news.
To be fair, none of these things fall directly under the purview of the Fed’s dual mandate of stable prices and maximum sustainable employment, but hot, if not overheated, financial markets do nothing to quell prices that are already rising faster than the Fed would like. At some level, the market recognizes this. On the day after the September 18th meeting, Fed Funds futures were pricing in a rate of 2.85% for December 2025. The current expectation is for 3.81%, nearly a full point higher. That is considerably above the median expectation of 3.375% expressed in the most recent “dot plot”, the Summary of Economic Projections from the FOMC’s September meeting. Considering that the market has spent most of the past year pricing in more aggressive rate cuts than the Fed was willing to offer, this is a significant change in sentiment.
And that is why I am concerned that the Fed is ready to spike the football before reaching the end zone. For those of you who don’t follow American football, that occurs when a player prematurely celebrates scoring a touchdown. In this recent example, the New York Jets (my hapless team) were able to win the game in spite of this mindless blunder. But the folks on the FOMC need to have a better record than the Jets, who perpetually disappoint. Today’s stock market reaction is more of a relief rally, with as expected inflation statistics doing nothing to upset the prevailing trend. But the Fed and the markets need to get on the same page about rates and inflation. We can’t fight inflation by lowering rates.
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