Far From It
The FOMC's regional revolt, QT ends but SOMA duration runoff begins, the size of the balance sheet and bank regs, risk-off risks rising
In this week’s note:
The FOMC took two hawkish steps this week. The first was the regional revolt against the October cut, and even stronger pushback against another cut in December. The second, less understood, incrementally hawkish policy change was the decision to reinvest mortgage paydowns beginning December 1 into Treasury bills, rather than notes.
The decision to end QT, and internal debate about the lowest comfortable level of bank reserves, misses the most important issue, bank regulatory policy. Chair Powell is slow walking changes proposals from Vice Chair for Supervision Bowman; the next Chair will accelerate the regulatory loosening. This is the path to Kevin Warsh’s suggestion that the Fed should shrink its balance sheet to increase bank lending.
The Fed’s assessment of the labor market is overly optimistic; our review of October Regional Fed surveys and the Conference Board’s October Labor Differential suggest demand continued to weaken due to a combination of the three policy shocks and the impact of the Fed’s restrictive rate policy on small banks and businesses.
The October regional Fed surveys imply orders, inventories, capital spending and labor demand remain soft. There has been no discernible rebound since the passage of One Triple B.
We review earnings momentum and valuation with earnings season winding down. The equal weighted S&P 500 relative valuation is at the low end of the historical range, but relative earnings growth is weak.
The Fed’s hawkishness risks a counter-seasonal risk off episode. Caution is warranted.