Today is Hump Day, but it’s not an ordinary Hump Day. It is setting up to be an extraordinary Hump Day. That’s because there will be an FOMC policy decision published at 2:00 p.m. ET and it will be accompanied by an updated Summary of Economic Projections that will include a new median estimate for the Fed’s terminal rate. Fed Chair Powell will then follow with a 2:30 p.m. ET press conference to try to explain it all.
How the Fed Chair explains things will go a long way toward determining if the market can get over the hump with its fear of the Fed.
That’s a big hump judging by the deep inversions across the Treasury yield curve, and it is a big ask of the Fed Chair to sound like a softie with the consumer inflation rate still north of 7.0% and average hourly earnings up 5.1% year-over-year.
The inability to sustain yesterday’s rally effort had much to do we think with some angst that the Fed Chair will remain inclined to emphasize that inflation is still far too high, pointing to the stickiness of core services inflation and a tight labor market, and that the Fed has more work to do to bring inflation down to the 2% target.
That thinking could be codified in the Summary of Economic Projections with a 50-basis point increase in the median estimate for the terminal rate from 4.60% in September. The fed funds futures market is aligned more with a 25-basis point increase for the terminal rate estimate, evidenced by pricing in a 69.6% probability that the terminal rate will be 4.75-5.00% by mid-2023.
Of course, by now, the market must realize that what the Fed puts on paper is written in pencil since the forecasts are always subject to revision. Accordingly, if the Fed’s median estimate for the terminal rate is higher than what the market expects, the response will have a lot to do with whether the market actually believes/fears the Fed is destined to go there.
That’s where the tone and cadence from Fed Chair Powell will have an outsized impact today.
It is widely expected that the FOMC will vote to raise the target range for the fed funds rate by 50 basis points to 4.25-4.50%. There will be some added interest in whether that vote is unanimous. For what it’s worth, the fed funds futures market places a 20.6% probability on a 75-basis points rate increase, according to the CME FedWatch Tool.
Regardless, the policy rate is going higher today, which also means rates on variable rate debt are going higher today, too, increasing repayment burdens for holders of revolving debt and installment payments for borrowers seeking new fixed-rate loans. That reality will be an inevitable drag on economic activity and it will be incorporated in the market’s concerns about the long and variable lags of monetary policy on economic activity.
Those lags are a big hump for the U.S. economy and global economy. The ECB and Bank of England are holding policy meetings on Thursday and they are also expected to announce 50-basis point rate hikes in their policy rates.
The hump for now is the FOMC decision and the market is hesitating to climb over it, notwithstanding some encouraging Q4 and FY23 EPS guidance from Delta Air Lines (DAL).
Currently, the S&P 500 futures are down three points and are trading slightly below fair value, the Nasdaq 100 futures are down 17 points and are trading 0.1% below fair value, and the Dow Jones Industrial Average futures are up five points and are trading roughly in-line with fair value.
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Originally Posted December 14, 2022 – Market faces a big hump on this Hump Day
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