“To rest upon a formula is a slumber that, prolonged, means death.” – Oliver Wendell Homes
The Fed did their best at the November meeting to extend the Halloween season. But their hawkish hand had been forced by the pre-emptive market rally over the past two weeks. As a result, they put the spook back into the doves. But what they really intended was to refocus the market on brass tacks, which, to them, is the upcoming inflation and employment data.
They also felt the need to come clean on the lag that their policies have on the broad economy. It takes time for homeowners, consumers, and businesses to reset their expectations for borrowing at higher interest rates. The easy pocket cash generated by refinancing debt goes away when they raise rates, but not instantaneously. In the meantime, many Americans are still enjoying the real and psychological benefits of the Fed’s prolonged era of zero-interest rate policies.
In a remarkable thirty minutes of trading following the release of the Fed’s written statement, both rates and spreads rallied. But in the bond market’s “hall of mirrors”, where the market is looking to the Fed for cues and the Fed is looking to the market for cues, Powell felt compelled to throw cold water on the rally with his presser commentary. He accomplished this most poignantly by stating that it is “very premature to think about pausing rate hikes” and the ultimate peak in their rate may be “higher than previously expected.”
While this was very hawkish speak, the bond market should be careful about using it to meaningfully reprice the implied Fed path. His comments should be interpreted more as the Fed lifting a perceived market ceiling on a potential range of paths. Where their peak rate ultimately ends up is still based on highly uncertain incoming data (along with an uncertain lag). But with an impending slow-down in the pace of their hikes, the Fed is buying more time for inflation and employment data trends to reveal their longer-term tendencies.
One thing is for sure, the bond market is hurtling towards the start of a new calendar year with tremendous sensitivity and volatility around this economic uncertainty. Before we conclude that bond performance could be a redux of an extremely painful 2022, we must remember that current market pricing, both in rates and spreads, is far more reflective of this uncertainty than it was entering this calendar year. After all, was it Socrates or Yogi Berra who said, “There are no bad bonds, only bad prices”?