Reflexively Following The Fed

This Is So Ducking Stupid

I’m so baffled by the continual cycling that we have been going through over the last 18 months as to the pace of cutting cycles in the US. Sure, I get it, the pace that the Fed needs to cut will depend on progress on deflation and the outlook for the labour market and broader economy. But this just seems stupid at this point.

Look at the chart below. This is so up and down it could be an ECG (admittedly of someone who should probably go for a check up). Financial markets have repeatedly overswung and reversed on expectations of Fed pricing.

Sure, this is a clear reaction to changing economic data, with the shifts in expectations largely corresponding to economic surprises per the Citi US economic surprise index (chart grabbed from MacroMicro).

And yes, there have been quite a few missteps from the Fed in line with reenforcing the impact of economic surprises. The emphasis on data dependence, huge shifts in narratives between Fed meets, and the periodic rolling Waller out to signal a turn have surely added to volatility.

BUT, markets have just followed course almost every single time. Fed says jump, we say how high or some shit.

I’m not going to take a view on where rates are going to be or should be by end-2025, but, I am going to take a view that it is stupid to completely anchor a view on the rapidly evolving economic data and the volatile narratives coming out of the Fed.

Obviously this is easy to say in hindsight, but the best way to trade this Fed was just to bet on six month trends in the FFR that completely retrace the following six months. Which makes sense because 1) data struggles to continually surprise as expectations increase or fall in line with the trend and 2) surprises drive rate expectations which countercyclically impact growth which then feed back into rate expectations.

Sure, things may be different this time and there may have been a regime shift with D Trump in the hot seat. But rate expectations are now back at extremes, meaning further upside may be capped (will the Fed put rate hikes back on the table?) and data will have to continue to outperform increasingly higher expectations, while rates are significantly higher. AND, if rates stay high, and equity wobbles become something more serious we may have another serious countercyclical driver.

Of course, because the Fed is so big and important, we’ve also seen UK and to a lesser extent eurozone rate pricing get bitched about. Does it make sense? Sure the US curve has a big impact and the BoE in particular doesn’t often diverge from the Fed, but the BoE and ECB do both appear to have developed somewhat independent strategies for the cutting cycle (BoE with its 3 cases and the ECB with the consistent ahhh cut cut cut). I’m not sure it does make sense.

I’m not going to advocate a certain view point here. But I’m advocating having an independent view point, and weighing the incoming economic data vs your existing narrative. Don’t shit the bed on every data print or every time the Fed shifts tone – they don’t exactly have a great track record.

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