Posted | by David Moenning |
Words Matter image

Stop me if you've heard this one before. Pullbacks in the markets end quickly when some Fed official, or better yet, a couple FOMC members say something "dovish." You know, something like, "We see signs of progress on inflation." Or "Policy is appropriate given the current data." Or, well, anything including the words "rates" and "cuts" in the same paragraph.

Almost instantly, the computers of Wall Street's high speed trading crowd start buying in response. Never mind the fact that Jay Powell & Co. have made it very clear, as in "crystal" clear, that the Fed is in a data dependent mode and that rates are expected to remain "higher for longer" until the committee gets what they want. I.E. Inflation moving back to/toward their stated 2% target.

Forget about that. No, when dovish comments arise, traders large and small start salivating about the idea of the Fed having their backs again. Being "friendly" as opposed to antagonistic. And for rates to be moving down instead of up.

Before long, all anybody can talk about is how quickly the Fed is going to "pivot" from rate hikes to rate cuts. Bets are made. Futures are bought. Shorts are covered. Cash comes off the sidelines. Optimism returns. And just like that, Wall Street finds itself in its happy place.

We've Seen This Movie Before

Well, for a while, anyway. But then it happens. Just about the time the S&P 500 starts to make some progress on the charts, somebody, or in this case, Fed Chair Jerome Powell, "pushes back" on the theme that has created the recent enthusiasm.

Instead of joining the chorus that the Fed will start cutting rates - and soon - the head of the Federal Reserve has time and again reminded everyone that his merry band of central bankers isn't even thinking about thinking about cutting rates. He goes on to use the phrase "higher for longer" early and often when speaking publicly and continues to beat the "data dependent" drum when asked about the future.

These so-called "pushbacks" tend to cause the air to come out of the optimist's collective balloon in a fairly swift fashion. The bears then come out of hibernation and ramble on about an upcoming recession, the doom, and the gloom that is sure to come. You know, that very same recession song they've been singing since early 2022. (Remember, those in the business of making predictions in the market tend to make them early and often.)

So, with the Fed refusing to yield and folks questioning the outlook for the economy, the rate-cut infused rally ends, and the next pullback ensues. Rinse and repeat.

Will This Time Be Different?

Until now, that is. Maybe.

But maybe, just maybe, the narrative out of the Fed is changing. For real this time. And this is the reason that stocks have been unable to come off their rather high perch of late. This is the reason that all those gaps on the S&P chart remain open. This is the reason the most recent run for the roses hasn't failed (yet). And this is the reason that traders remain optimistic about an upcoming visit by one Mr. Claus at the corner of Broad and Wall.

To be sure, parsing Fedspeak requires a higher degree from Wall Street's School of Hard Knocks. A degree that I believe I've earned (the hard way, of course). And from my seat, it appears that the new message from Powell & friends is "enough is enough."

Here's my argument. Last Tuesday, Fed Governor Waller said he is increasingly confident that Fed policy is well positioned and that if inflation goes down, there is no reason to insist rates remain "really high." He went on to suggest that the Fed's response should be to... wait for it... lower policy rate. Wow!

The key here is that according to reports from folks I trust, Waller has historically been a bellwether of changes around Fed's narrative. Thus, analysts were quick to point out that Waller's comments may signal emerging dovish turn for the Fed. I'll say it again, wow.

Or... Was he just talking out of school? Don't forget that we've heard uber-dovish comments from Fed officials before. Comments that tend to be quickly walked back.

But this time, and it's been over a week now, there has been no walking the comments back. And perhaps more importantly, the usual pushback from Jay Powell on (a) Waller's words and/or (b) the market's growing expectations for rate cuts early next year, didn't happen during his most recent public appearance. Now we're talking.

Higher For a Little Longer

Make no mistake about it; the Fed's credibility is on the line here. As such, we should not (as in, absolutely NOT) expect to hear any overt mentions of rate cuts from Federal Reserve officials. No, it's the market's job to parse the words used - or in this case, the words not used, to determine the message from the Fed.

So, based on the words used and not used over the last week and a half, I'm going to opine that the Fed's new message is that as long as inflation remains on its current trajectory, rates are going to stay "really high" (Waller's words) for a "little longer." Let's say six months or so.

No, I don't expect Powell to pivot quickly. And I believe the calls for rate cuts in Q1 2024 are off base - assuming the economy remains on its current path. After all, it's early days for the downtrend in inflation and the Fed needs to be convinced that inflation will indeed get back to its target (a target that has never before been tested in this direction, by the way) in a reasonable time. But I'm of the mind that this is a bullish development.

Is this enough to convince Santa to make an appearance again this year? Is this the issue that will cause FOMO and/or portfolio window dressing to goose prices into year-end? Time will tell of course. And history does suggest that some weakness in early December is normal. But for now, I'm going to keep my seat on the bull train.

Thought for the Day:

The unexpected happens. You had best prepare for it. -Margaret Thatcher

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research, a Registered Investment Advisor


At the time of publication, Mr. Moenning held long positions in the following securities mentioned: None - Note that positions may change at any time.