Put it to Bed
February 3rd, 1959 was the day that rock and roll musicians Buddy Holly, Ritchie Valens, and J.P. Richardson (aka The Big Bopper) were killed in a plane crash in Iowa. That day has become known as “The Day the Music Died” after Don Mclean referred to it as such in his 1971 song titled “American Pie”. As a side note, I recently watch the documentary by the same title about the making of this iconic song and it is worthy of your time. Anyways, I bring this up because I couldn’t help thinking about this song on Tuesday November 28. On this day, the Federal Reserve’s 2023 mantra “Higher for Longer” died when the Fed’s Christoper Waller uttered these words:
“There’s good economic arguments that if inflation continues falling for several more months, you could lower policy rate.”
Waller is known as a policy hawk so for him to say this marks a real turn since he is the first policymaker to even hint at possible interest rate cuts. At the end of the week, Fed Governor Jerome Powell had two opportunities to push back on Waller’s statement and he chose not to, which is also very revealing.
Waller’s comments pushed on a door that was already open. In other words, he didn’t say anything the market hadn’t already concluded – that the Fed was done with hiking rates. Let’s face it, the Fed’s last hike was back in July – did you really think they were going to strike again? Traders had already sniffed this out by selling the USD hard across the board. The daily chart of the US dollar index shows that it topped out in the last week of October. As you can see from the monthly performance, the USD was down across the board from as low as 2% against the yen and as high as 5.5% against the NZD. While I continue to believe that this trend will carry on, the selling in the month of November may have been a little too much. Thus, we are due for a bounce in the USD to correct the oversold conditions.
The first rate cut is now fully discounted for May from almost 58% chance before Waller’s comments. The implied yield of the December 2024 Fed funds futures contract is about 4.34% implying about 100 bps of cuts next year.
The Fed’s last meeting of this year is December 13th, but it will be a non-event, thanks to Waller. The Federal Reserve is now officially on the sidelines, its only role from here on in will be when and how it will respond to the economic slowdown which is sure to come after one of the greatest hiking cycles in Fed history.
The Fed isn’t a lone, it is generally accepted that most global central banks, except the Bank of Japan, have most likely completed their monetary tightening cycle. They will now turn to trying to push against a premature easing of financial conditions with their words.
With that said, since the Bank of Canada was one of the first central banks to hike rates, I suspect that it will be the first to cut rates in the new year. The Canadian economy is weak, it contracted by 1.1% in Q3, the worst performance among the G7. The market is pricing in almost a 70% chance of a rate cut in last Q1 2024 and has fully discounted another three cuts by the end of Q3.
The low in the CAD versus the USD was on November 1 and then preceded to move higher for the rest of the month, snapping a three-month drop. Even though, I expect the BOC to cut rates before the Fed, I don’t expect the CAD to underperform against the USD because the dominant trend is for a lower USD globally. As I pointed out before the USD has fallen too much and too quickly in November, so I do expect the CAD to pull back a little to work off the overbought condiscountdition before powering higher again.
