Fed transparency = market volatility

Markets have fallen since the worse-than-expected CPI reading, and the latest hawkishness by the Fed means no Powell “pivot”, no Fed “selling”, and no soft landing. The table shows the market peak of the four major indices, the level and percentage of changes to the market bottom at the end of June, the levels and percentage changes from the high of the “bear market” in mid-August, and where the market is in relation to the year-end peak at the close on Thursday, September 22nd.

Note that the DJIA and S&P 500 have now fallen below their June lows, with the other two indices within a hair’s breadth. A break below those bottoms is, from a technician’s point of view, bad news for the stock markets.

Fed hawks

The Federal Reserve announced an expected 75 basis point interest rate hike on Wednesday, but what surprised markets were the implied hikes in interest rates of 125 basis point shown by the new year-end chart. On the dot graph, the 125 basis point rise in 2022 is shown as the average of the yellow points and are the newly released estimates from each FOMC member. Gray dots is the September version. Note that the average points for September (gray) peaked at 3.75% in 2023. The new (yellow) points have now peaked above 4.50% in 2023. Also note that the point chart for 2024 has no consensus. Points are spread across nine different rates from the 13 FOMC members in the 2.6% to 4.6% range. A similar situation exists for 2025. This suggests that there is no economic consensus among FOMC members with those in the higher range who do not see the current dip in inflation or the next recession. This is despite the fact that their GDP forecast has been trimmed from +1.7% for 2022 to +0.2% and to +1.2% from +1.7% for 2023.

Prior to 2012, the Fed did not discuss its future views with the market. FOMC members have been very vocal about what happened at the Fed meetings. There were no press conferences after the meeting. All the market knew was the Fed rate-setting procedure. In the world of the Federal Reserve today, we have connections to the price forecasts of individual FOMC members. Since the start of the dot-plot era in 2012, the accuracy of these predictions has reached 37%. However, today the market views it as gospel and the markets immediately switch to average expectations. It’s funny, though, that President Powell insists that every Fed meeting is based on incoming data, not on what appears in the score chart. However, the Fed’s apparent “transparency” (i.e. raster charts) causes volatility as markets immediately re-price the new (low-resolution) raster. The system was much less volatile when there was no transparency. Perhaps it would be better to go back to this opaque system, where the FOMC actions were really on a one-to-one basis and dependent on incoming data. In this system, market volatility will subside.


The +0.1% m/m rise in the headline CPI in August (consensus was -0.1%) has led some economists to suggest that inflation has become endemic. The real problem with the report was the +0.6% rise in the “core” rate (excluding food and energy). But there is plenty of evidence for signs of easing price pressures (apparently everywhere except for the official CPI!).

  • Gasoline prices fell 9% in August and continued to decline in September.
  • Natural gas prices have stabilized. This will soon affect utility bills.
  • There have been significant drops in the prices of grain, dairy and other agricultural products which should soon match the prices at the grocery store.
  • The prices of used cars at the auction have fallen significantly.
  • Supply chain improvements will lower consumer inflation, and a stronger dollar will continue to drive prices for imported goods (down -1.0% in August and -1.5% in July).
  • Rents will continue to put upward pressure on measured inflation, but much of that is due to the old way that the BLS measures. Already, private sector rents have slowed sharply.
  • There are signs of abating service inflation. Travel sensitive categories, which include hotels and airlines, have seen price drops recently.
  • The CPI version of health care costs is still accelerating, but the more comprehensive measure of PCE (which the Fed is looking at) is trending lower.
  • Surveys about pricing intentions have been declining in recent months.
  • Inflation expectations are well established (even according to Chairman Powell). This indicates that the risks of the wage-price spiral are negligible.
  • There was little evidence in the CPI report of lower prices due to inventory liquidation, but this is true.
  • Core Crude PPI (food and energy – very early stages of production) fell -1.6% yoy in August. A year ago, at this time it was +42%!
  • The median core PPI (ex-food and energy for semi-finished goods) fell -0.9%m/m in August and was -0.2%m/m in July.

The incoming data continues to confirm our view that inflation will subside soon. We expect both headline and core inflation to decline more quickly in the coming months than Fed officials currently believe.

Labor market

We’re finding it hard to digest the August payroll data. On a seasonally unadjusted (NSA) basis, year-to-August salaries were up +2.2 million. But, seasonally adjusted (SA), which is the main data, that number is +3.5 million. There is a difference of 1.3 million. Theoretically, over the course of a year, the SA process should go to zero with NSA data. This means one of two things: 1) seasonal factors will be negative to 1.2 million payrolls in September-December (that’s 300,000 per month!), or 2) historical data will be revised down. If 1) is the case, then the markets will react; But if 2), expect little backlash because reviews are usually ignored by the media and analysts. However, the job market is simply not as strong as the payroll data (and President Powell’s) believe. In fact, the Fed itself sees the unemployment rate rising to 4.4% in 2023, which in itself means a recession. We think this is overly optimistic and we think the U3 average will have an index of at least 5.

More data

  • There was a slight pickup in consumer confidence in September, no doubt due to lower gasoline prices. The University of Michigan Consumer Sentiment Index rose to 59.5 (preliminary) from 58.0 in August. This is not something to write about because the indicator is still looking for dips (see chart). We’ve also included a home purchase terms chart. It, too, continues to investigate historical lows, as do similar charts for large household durables and automobiles.
  • FedEx, the “heartbeat” of the economy, dropped a bombshell last week. Earnings came in at $3.44/share. Markets were expecting $5.10. The company noticed a significant drop in traffic and indicated that it would close sites and reduce staffing.
  • So. Korean exports of chips in August fell at the fastest pace in three years and fell 24.7% year on year.
  • Purchasing Managers’ Indexes (PMIs) in China, UK, Canada, Germany, Italy, Spain etc. All of Korea was below 50 (a contraction) in August which caused the World Bank to announce that a global recession had begun.
  • In Australia, house prices are falling at the fastest pace since 1983; In Canada, the median home price fell -1.6% in August and fell -7.4% over the past six months.
  • In the US, existing home sales fell -0.4% in August, falling for seven consecutive months and -20% below last year’s levels (see chart). Average price is -6% lower than last March’s peak. The expectation is that the stock of homes for sale will decline because families with homes with a 3% mortgage won’t look to sell and upgrade with 30-year fixed-rate mortgages above 6.3%.
  • Mortgage applications continue to fall with purchase orders down -29% year over year and refinancing applications down a whopping -83%. Redfin reported that 21% of homes for sale had their asking price lowered in July. (None of this is captured in the August CPI!)
  • Retail sales showed a 0.3% month-over-month increase in August. This is based on my name. Ex-auto sales fell 0.3%. July data was revised down to -0.4%, so nominal sales for August came in below initial estimates for July. So far, for the third quarter, retail sales have been negative.
  • Industrial production is also disappointing, falling -0.2% in August, and flat or down in three of the past four months.
  • As a result of hawkish Fed, the dollar continued to strengthen, import prices fell -1.0% in August on top of the July drop -1.5%. But despite the dollar’s strength and its impact on import prices, auto imports fell 0.1%, the first decline since November 2020.
  • The Philadelphia Fed Manufacturing Index showed a rise in September at -9.9%, down from +6.2% in August. The New York Fed’s Empire Manufacturing Index was similar -1.5% in September, up from -31.3% in August. This is somewhat better, but still shows shrinkage. In the Philly Index, New Orders, Inventories, Workweek and Expectations were negative. Although the indicators for shipping and employment remain positive, they are significantly lower than in August. The good news is that both surveys showed a significant decrease in the percentage of companies that paid or received higher prices for the month, and both showed significant reductions in delivery delays (graph). The former indicates lower inflationary pressures, while the latter indicates a loosening of supply chains.

last thoughts

As can be seen from the incoming data, the economy has entered a recession. However, the Fed, which is clearly ignoring the incoming data and focusing on lagging indicators (i.e. year-on-year inflation and unemployment rate), has become more hawkish and has now told the market that it intends to raise rates by 125 again. basis points before the end of the year and more in 2023. The dot chart has historically had a 37% correlation with what is really happening with regards to rates, and FOMC members are clearly nowhere near a consensus on the 2024 and 2025 rate levels. The M/M CPI for July was -0.1% and the August Index was +0.1%. During these two months, the headline CPI was flat (ie 0%). The Fed seems to have to realize this, especially since monetary policy affects the economy with long and variable delays. However, this Fed is still moving forward with an increasingly restrictive policy, and it appears impervious to the late effects of previous interest rate hikes. This is in the face of two consecutive quarters of negative GDP and almost daily evidence that the economy is shrinking.

Powell referred to Paul Volcker several times, both in public statements, and in his remarks to Congress, regarding Volcker as a hero to be emulated. Naturally, Volker killed the inflation dragon, but the cost came in two big recessions. Volcker knew that monetary policy acted with long delays because he moved the federal funds rate lowest When the inflation scale Y / Y is still more than 11%! The continuation of more restrictive monetary policy (including quantitative tightening (QT)), which has already pushed the economy into the throes of an initial recession, will only make this recession deeper and longer.

(Joshua Barron contributed to this blog)

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