Macro Insights: Is an early Fed pivot likely? Macro Insights: Is an early Fed pivot likely? Macro Insights: Is an early Fed pivot likely?

Macro Insights: Is an early Fed pivot likely?

Charu Chanana

Head of FX Strategy

Summary:  A bunch of different factors are coming together, putting more weight on the argument of an early Fed pivot and a peak in global central bank hawkishness. These have included somewhat softer economic data out of the US this week, plus the financial instability risks, and the pivot from Reserve Bank of Australia to a slower pace of rate hikes lately. We put all this in perspective, and how it is still premature to expect a Fed pivot unless we see clear signs of disinflation.

Why do we have increasing calls for a Fed pivot lately?

A slight weakness in US economic data this week has been quite a turn from the upbeat data that we have been getting out for the economy until last week. US consumer confidence data rose to 108 in September, smashing expectations, with both present situation and expectations marching higher. Thereafter, we had the first sub-200k weekly jobless claims print since May, suggesting that the labor market remains tight.

But this week, the tables turned with a weaker-than-expected ISM manufacturing print and a sluggish JOLTs job openings which hinted at the tightness of the labor market moderating. But these few data points do not confirm any change in trend, or the Fed policy.

RBA pivot fueling calls for a peak in global central bank hawkishness

When one of the G7 central banks pivot, shock waves are expected. But the case for the Reserve Bank of Australia is somewhat more unique. It’s signal to slow down the pace of rate hikes has stemmed from concerns about the impact on housing market and household budgets. Also, the market pricing for RBA was aggressive with a 4% peak priced in.

The US economy is more domestic driven, especially with lower dependence on China’s activity levels, and therefore has significantly higher room to whether the central bank tightening. It is also worth keeping in mind that the RBA meets every month, so it can get a lot of tightening done even with 25bps rate hike every month, compared to some of the other central banks that meet less often. The Reserve Bank of New Zealand’s 50bps rate hike today has rather confirmed that we are still some way off from a pivot from the Fed or other global central banks.

Some things are breaking

Well, we have often heard the saying that Fed will hike until something breaks. And things are breaking, from a slow break of the Japanese yen to the quick crash of the UK Gilts market. Potentially, something breaking in the financial markets could make the Fed pivot faster than the domestic economy breaking, as it appears now. It will be important to monitor the broader measures of financial stress, such as the ECB Systemic Risk Indicator as highlighted by my colleague here. For now, we do not see any systemic risks, and a larger pool of money than say the UK pension fund industry, will have to be in trouble to really spell pivot for central banks.

Fed is in the “Volcker” mindset

Fed’s Chair Powell has invoked his inner Volcker with his message at Jackson Hole getting sharper about inflation. It is clear that persistently high inflation is damaging to central bank credibility and so they will want to know inflation is well and truly crushed before making any moves to pivot, thereby avoiding any mistakes of the past where an early Fed pivot made the fight against inflation that much harder. History has shown that pivoting too early can lead to resurgent inflation as was the case in the 1970s (see chart below). Unlike his predecessors, Fed Chair Volcker kept interest rates at elevated levels after inflation peaked, and only pivoted in 1982, having started raising rates in 1979.

Source: Bloomberg, Saxo

The Fed officials have been giving out a clear message lately on the goal of getting inflation under control, without being concerned about the domestic economy or the turmoil in the global financial markets. While the two key indicators, Friday’s monthly payroll report and the monthly CPI data on October 13, could still distort the market pricing of the Fed’s message, that would make the Fed’s job that much harder.

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