Markets want 25 bps. Tariffs and jobs complicate it. Here’s how today’s dots could drive the tape.
KEY TAKEAWAYS
The Fed gets ready for a risky “double pivot” as tariffs pressure prices and jobs soften
Markets expect a 25-bps cut today with dots likely to drive the reaction more than policy
Political jawboning is unprecedented and adds pressure, but Powell’s single vote still sways the narrative
The bond market’s response at 2:01 PM ET will reveal term premium and inflation expectations
History says sell the news risk first, constructive path later if guidance is coherent
MY HOT TAKES
A 25-bps cut with dovish dots is the market-friendly path of least resistance
Anything shy of 25 bps triggers a two-asset selloff; 50 bps risks spooking bonds
Powell’s tone management is as important as the median dot
Watch two-year yields and the curve more than the S&P’s first candle
Politics raises the volume, but economics still writes the song
You can quote me: “Goods inflation has indeed ticked higher, but marginally, and if one observes the chart with no bias, it is clear that goods inflation began trending higher well before tariffs were even announced.”
The season of dove. Will they achieve it? Will they even attempt it? The Fed’s Federal Open Market Committee (FOMC) will deliver its policy decision this afternoon, and spectators will be glued to the action, waiting to see if the Fed will deliver its long-awaited double-pivot.
From an inflation hawk’s view, it is a dangerous move. Interest rates are currently restrictive with the Fed Funds Rate sitting at 4.5% since the Fed’s last cut in December of last year. Since that cut, the FOMC, including Chair Powell himself, became markedly, mildly hawkish, turning an ice-cold shoulder to the cut-thirsty equity markets. It was a soft pivot. I say “soft” and “mildly” because the Fed did not resort to raising rates, but rather, it simply stopped normalizing the already restrictive rate–kind of like riding the brakes when you see traffic in the far distance.
That traffic that the Fed saw, was inflation caused by the administration's overtly aggressive tariff policy. We all know by now that tariffs are inflationary–no one argues against that, even the President himself. What is up for debate is just how inflationary–the magnitude, when it will come, and how long will it last. Will it even affect consumer prices, or will importers and exporters eat the bulk of the taxes? Will a consumer price hike be simply just that–a hike, or will it spur a continuous spate of price increases, causing inflation to fester long into the future. Obviously, the latter scenario is the one which we most fear, and incidentally the one that the Fed needs to worry most about.
There have been 6 FOMC meetings since the last rate hike and the FOMC has kept rates level while jawboning the markets into lowering its expectations for relief. The Fed’s favorite “data dependent” stance, which amounts to “wait-and-see,” has, for the most part, yielded very little to… well, see. Goods inflation has indeed ticked higher, but marginally, and if one observes the chart with no bias, it is clear that goods inflation began trending higher well before tariffs were even announced.
But the intermission was not without any drama. We did see, more recently, a significant downshift in jobs creation over the past several months. No matter how you slice it, those numbers are flashing warning signs. Warning signs that even the Fed can’t ignore. To be clear, the economy is not exactly on the rocks, but the labor market is certainly on its heels, which can have significant negative reverberations for the broader economy in the near future.
Now, we can’t ignore the elephant in the room. All Presidents want lower interest rates–all have different reasons. Some Presidents are more vocal about their desires than others, but 47 has taken it to a new level, redefining the term jawboning. The President is applying every legal pound of pressure that he can on the bankers, even resorting to attempting to fire an FOMC governor. Interestingly, Governor Lisa Cook, who is fighting to keep her job, is a known dove, more likely to vote in favor of cuts. That said, the President has done what he can to keep pressure on all members of the FOMC–keeping them wondering “am I next?”
Just yesterday, the newest member of the FOMC was sworn in–Stephen Miran, who was nominated by President Trump to temporarily fill a vacancy left by retiring Governor Adriana Kugler, who was a known hawk. Miran, a Trump camp insider, will join openly dovish Chris Waller and Michelle Bowman, who both dissented at the last meeting. NY Fed’s John Williams rounds out the list of known doves voting today. Alberto Musalem (St. Louis) and Jeffrey Schmid (Kansas City) are the known hawks who will be voting, and the remaining 5 are known to be neutral. So that leaves us with 5 doves (including Cook), 5 neutrals (including Powell), and 2 hawks voting today. Powell has just one vote, and for his part, he has made recent, dovish overtures, most notably at Jackson Hole. Though he has one vote, he has the power to sway the broader committee.
It is for all these reasons that the markets are largely expecting a rate cut today. Expected: 25 basis points. Hoped for: 50 basis points. Likely: 25 basis points. Anything less than 25 will be painful for equities and bonds–very painful. Anything more is likely to get a positive response out of equities but a mixed response from bonds.
All this which I have just laid out for you has very much been the “rumor” on the street for the past several weeks, and equities have been rallying on it. This afternoon, at 2:00 PM Wall Street Time, we will get the “news,” and learn if the old Wall Street adage “buy the rumor, sell the news,” will prevail.
However, it may not be the actual rate cut decision that moves markets. Today, we will get the FOMC’s famous–more like infamous–SEP. SEP stands for Summary of Economic Projections in which each FOMC member submits their projections for a number of key indicators including GDP, inflation, unemployment rate, and Fed Funds. It is the Fed Funds projections that will be most scrutinized this afternoon. We get to see where all FOMC members expect rates to end up this year and over the next several years to come. Where they end up this year will obviously get the most attention with only 2 more meetings after today’s.
The actual yearend projections will show up in the SEP, which will be released this afternoon, and in the Fed’s much-opined-on Dot Plot. The last projection from June projected Fed Funds ending the year -50 basis points lower. Since then, Futures–in a not-so-direct path–have lowered year end projections to include a high probability of -75 basis points worth of cuts. Futures give a 100% chance of 50 bps and a 75% chance of another 25 bps between today and year end. The dots will likely have more influence on markets this afternoon than the policy itself. As usual, Powell's comments will certainly influence how the policy is received. If he sticks to a similar narrative to Jackson Hole, a 25 basis-point cut will have neutral to positive net impact on equities. Powell is a pro, and if he veers, it will be for a reason, and it will certainly cause movements in the markets.
I have been mostly referring to equity markets throughout this discussion, but how the fixed income markets react to today’s policy and data dump will most likely give us the best clues about the future. The yield curve between 2-year and 10-year Treasury notes has been on the move throughout the summer. The moves have been dictated by changes in rate cut expectations, required term premiums, future inflation expectations, and of course expected economic conditions. By 2:01 PM Wall Street Time this afternoon, we will get data points on each of those.
The double pivot has been tried before and has been, for the most part, received well. Expectations are high–will Wall Street sell the news? History tells us that it might, but that markets will perform well in the longer run. Your mission today: pay attention to what the Chair says in his presser, look closely at changes in the SEP, and pay very close attention to the bond market. Dim lights, cue music… the show is about to begin.
YESTERDAY’S MARKETS
Stocks traded lower yesterday despite a solid Retail Sales print that likely reflected back to school buying but was still above estimates. All remained firmly focused on today’s FOMC meeting which will illuminate the way forward–at least until Q3 earnings season which begins in a little under a month. 😳
NEXT UP
Housing Starts (August) is expected to have declined by -4.4% after climbing by 5.2% in July.
Building Permits (August) may have increased by 0.6% after slipping by -2.2% in the prior period.
FOMC policy announcement and SEP release will be at 2:00 PM Wall Street Time. The Chair will hold a press conference at 2:30. The FOMC is largely expected to cut the Fed Funds rate by 25 basis points.