Here’s the ‘Twist’ on the Fed as I Bet It Has to Cut Faster Than Market Expects
Let's discuss what's next after the FOMC announcement, Powell finally mentioning 'birth/death' issues, 'third mandate' talk, and, of course, bond yields.
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The Fed is now pricing in three cuts for the year (including Wednesday’s). I still think 75 basis points could be in the works, but 50 is a lock unless we get some positive jobs results, which I’m not yet seeing signs of.
For the end of next year, the dots median is 3.375%, down from 3.625% — in line with our belief that Fed will have to move faster than previously thought (I still think we get there sooner than the market is currently pricing).
The terminal rate did not change — median of 3% and average of 3.12%.
Fed Chair Powell mentioned “known” issues with the birth/death model! Wow, finally! We have been arguing that with the “gig” economy, the ease with which you can create an LLC, etc. has changed the nature of EIN (Employment Identification Number) applications. Each EIN issued does not coincide with the number of jobs attributed to it (they did at one time, but not for years). Hence all the adjustments.
As a reminder, from April through August this year (not touched by the big revisions of last week), the birth/death model says that the net number of jobs between companies being created (birth) and those going out of business (death) is 963,000! Total non-farm payrolls jobs for that period is 265,000. If the birth/death model still overstates jobs (and I think it does), have we actually lost jobs since the end of Q1? I think it is possible. The much maligned (rightfully so) Household report shows -114,000 jobs during that period. That is why I’m still willing to bet the Fed has to cut faster than what the market is pricing in.
The Fed is still behind on jobs, because the data are behind on jobs.
Powell killed the question on “third mandate” of stable long-term bond yields.
I still expect that we will see operation twist — selling short-term Treasuries to buy longer maturity Treasuries (even as the Treasury is also buying bonds). Will they “twist” into mortgages or do something similar with their mortgage portfolio? I think that would be stage 2, but is another reason to like mortgages.
First the Trump administration tries to “fix” yields — 10’s briefly got to 3.99%, and think they will get back there. Then you “fix” spreads, but first you fix yields, but expect mortgage yields to continue to decline as the administration tries different ways to achieve that stated goal.
They tried to steepen the curve but couldn’t. I continue to think we see flatter curves in the coming days.
Finally, from my Monday article, the one “surprise” no one is talking about – the possibility of Europe seizing Russia’s frozen reserves, and using that instead of debt issuance to pay for weapons.
I’m fighting the "sell the news" reaction, especially in bonds!
