A Strategic Shift in Market Expectations

The anticipation surrounding the impending interest rate slash has morphed into a rollercoaster ride in the last few days.

What was once a near certainty not too long ago has now become a source of heightened unpredictability, sending tremors of potential volatility through the market.

Let’s delve into this evolving saga.

From Quarter-Point to a Leap of 50 Basis Points

Merely a week ago, the prevailing market wisdom held firm that the Federal Reserve would opt for a modest quarter-point interest rate decrease at the upcoming September FOMC meeting.

The situation seemed all but set in stone. According to the CME Group’s FedWatch Tool, a staggering 85% probability was pinned on this single quarter-point slash earlier in the month.

So, why the sudden shift to a 63% chance of a daring 50-basis-point cut within a short span, fueled by two inflation reports hotter than anticipated?

Enter Nick Timiraos.

You might be wondering, who is Nick Timiraos?

Let’s rewind to a fascinating anecdote from a previous September documented in our vault. We shed light on insights from our hypergrowth connoisseur Luke Lango, referencing a pivotal Wall Street Journal (WSJ) article contributing to Federal Reserve policy discussions:

In Luke’s words:

The WSJ article held a pivotal significance – drafted by Nick Timiraos, the “Fed Whisperer”; almost everything he prognosticates about the Fed often pans out…

During my conversation with Luke for that archived piece, he remarked:

When Timiraos leans hawkish, Powell aligns hawkish. Similarly, when Timiraos adopts a dovish stance, Powell mirrors that sentiment. By design.

The Timiraos Revelation and Market Ripples

Fast forward to last Thursday, Timiraos sparked flames with his piece in the WSJ titled “The Fed’s Rate-Cut Dilemma: Start Big or Small?”

Did Timiraos intentionally spill the beans?

Delving into Timiraos’ piece, as Wall Street was leaning toward a concluded vision on the rate cut magnitude:

Federal Reserve Chair Jerome Powell faces a dilemma as the central bank readies for an interest rate cut next week: Kickstart with a modest approach or dive in headfirst?

The scenario approaching the Fed’s meeting on Sept. 17-18 marks the first rate reduction since 2020. With signals pointing to multiple rate cuts over the ensuing months, the quandary arises – is it a traditional 0.25 percentage point cut or a bolder 0.5-point cut…

Timiraos exhibited a degree of ambiguity, subtly hinting at both a 25-basis-point and a more audacious 50-basis-point cut. The needle tilted slightly towards the latter.

Here’s how he wrapped his narrative:

“We are at a juncture where you might contemplate, ‘I’m on the fence—25 or 50,’ yet the risk management now leans towards the labor market, endorsing the 50-point approach,” expressed Donald Kohn, a former Fed vice chair.

And just like that, whether it was Timiraos or Powell in disguise, the stage was struck by a metaphorical hand grenade.

Reflections on Forward Guidance

The Federal Reserve harbors a distaste for ambushing the market, traditionally favoring explicit signals ahead of policy shifts.

Forward guidance plays a pivotal role, disseminated through formal FOMC statements or trusted conduits in the press, such as Timiraos.

Recalling former Federal Reserve Chairman Ben Bernanke’s voice from 2013, emphasizing the nexus between Fed guidance and investor behavior:

The public’s anticipations concerning future policy actions wield significant influence today, shaping existing financial landscapes that in turn impact output, employment, and inflation across time…

Expectations around future monetary policy carry weight. They are so influential that a central bank can enhance policy efficacy by molding these expectations.

Guidance aims to curtail undue market turbulence and bewilderment, counter to the recent confusion stirred by Timiraos’ headline-grabbing article.

Multiple pundits have been puzzled, eyebrows furrowed at the repercussions of this eleventh-hour exposé. Take, for instance, analyst Jim Bianco airing his views on LinkedIn:

Timiraos is viewed as the fed’s mouthpiece. Rather than elucidating, a presumed intent of his narratives, the piece has propelled us from 14% to 50%, teetering at the pinnacle of uncertainty.

On the Fed’s end, Friday closed with fed fund futures showcasing a nightmare scenario: 49% odds of a 50 bps cut versus 51% for a 25 bps cut (chart). A mere whisper away from utter ambiguity (50/50).

Around half of Wall Street will be left aghast if this equilibrium extends unto Wednesday.

Forward guidance was crafted by the Fed (predict action before execution) to avert this exact turbulence.

The Elusive Search for Clarity

Owing to the sudden quandary, Bianco anticipated a clarifying piece on Monday from Timiraos to alleviate uncertainties. However, the piece surfaced today but failed to dispel the fog of uncertainty.

Once more, Timiraos straddled the divide, failing to strongly steer expectations back to a mere 25 basis points in my view.

What intrigued me most was the nebulous space Timiraos allowed to linger. Here’s a glimpse:

• Considering the imminent decision this week hangs by a thread, Powell might encounter at least one dissent among the 12 policymakers – five reserve-bank presidents, and seven Washington-based governors – shaping policy…
• The ambiguity surrounding this week’s verdict might mirror authentic uncertainty over the optimal choice…
• “At present, possibilities are pondered, ’25 or 50,’ triggering a shift in risk management favoring the latter,” as voiced by Donald Kohn, a former Fed vice chair.