It is no secret that Trump is a critic of the current Federal Reserve. He has frequently complained about Powell and wishes the Fed would take a more dovish stance. Well, he took a step towards making that dovish position a reality this week as he has just appointed two notable doves to the Fed. One is Judy Shelton, an economic adviser to his 2016 campaign, who will now be on the Fed’s board. The other is Christopher Waller, who will be the head of research at the St. Louis Fed. Shelton has numerous times expressed extremely dovish views and has said she does not like the Fed’s way of setting rates and would instead prefer a market-set rate.
FINSUM: Shelton’s views are pretty revolutionary, so it seems like she could really shake things up.
The market has the idea that the Fed holds a massive “put”. The concept entails that the Fed can effectively set a floor on asset prices because it can take dovish action to support markets at any point. However, that notion is problematic at the moment because a rate cut in the near term may actually induce a correction. In fact, markets look set for a lose-lose scenario. On the one hand, if the Fed does not cut rates, markets will be very disappointed and slump. On the other hand, investors have already priced in a near 100% chance of a rate hike, so it happening won’t give markets much of a boost and is more likely just to make investors worry that the economy is headed south.
FINSUM: We hate to say it, but we kind of buy into this view. Maybe not so much that markets will fall even if the Fed cuts rates, but the cuts certainly won’t be overly supportive at this point and may lead to a gradual decline.
We know, we know, a mortgage meltdown sounds like a claim coming out of left field. However, it comes from a potentially big issue that no one is paying attention to—the fact that the Fed is winding down its massive $1.6tn+ mortgage bond portfolio. As the Fed has begun to unwind its MBS portfolio, there are growing worries over the economy and real estate market. This could lead to a mortgage shock. Spreads between MBS and Treasuries have already risen as investors have grown nervous about oversupply.
FINSUM: So this is more of a technical issue than a fundamental one, but given the confluence of negative sentiment and oversupply, there is certainly some significant risk on the horizon for MBS.
There was a lot of anxiety yesterday about what the Fed might do. The big banks were taking the opposite side of markets, saying that the pace of rate cuts that investors expected were unrealistic. Then Fed chief Powell spoke and it became clear that markets were right, the Fed is completely dovish and has fallen in line with investor expectations. Powell signaled that rate cuts were on the immediate horizon, which has led markets to up their odds-making of a rate cut in July to 100%.
FINSUM: Powell was about as dovish as a central banker ever gets short of the middle of a crisis. For us this is quite an unusual situation—an economy doing well with both of the Fed’s dual targets being met, yet there is an undeniable sentiment towards cutting rates.
There is a lot riding on the results of the Fed’s meeting this week. Every big bank is weighing in and the consensus is that the markets have gotten too dovish in their projections and that the Fed won’t cut now, or as quickly as investors expect, all of which will lead to a decline in stocks. Both UBS and Goldman think that the pace of rate cuts forecasted by markets would only make sense in a recession, which seems unlikely. Morgan Stanley says stocks are very vulnerable to a decline if the Fed doesn’t cut as it will shift expectations and lead to tighter conditions. JP Morgan thinks equities will decline even if the Fed does cut.
FINSUM: We think the Fed will stay on hold for now but signal cuts in the Fall. We expect this will have a neutral to mildly negative effect on share prices.