Pro Perspectives 12/19/24

 

 

 

 

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December 19, 2024

We get the Fed's favored inflation gauge tomorrow morning.
 
But there should be little suspense.  Powell leaked it yesterday afternoon in his press conference. 
 
He said PCE for the twelve months through November should be 2.5%.  And the staff projections from yesterday's SEP (Summary of Economic Projections) suggest they see this month's number (the December PCE) ticking back down to 2.4%.
 
Let's take a close look at this "inflation target" concept.  
 
The Fed issued a formal statement on the level (2%) and their preferred gauge ("the change in the price index of for personal consumption expenditures") back in 2012 (here).
 
So, let's take a look at how they've done …
 
  
In the above chart, you can see they spent much of the post-Global Financial Crisis, pre-Pandemic decade running below 2%. And with this recent high inflation period, it leaves the 12-year average at 2.24%.
 
Keep in mind, in the middle of the decade-long bout with deflationary risks, the Fed told us that the inflation target was "symmetric."
 
And in 2020, when inflation was still sub-2%, Jerome Powell formalized this by saying they're just looking to "average" 2% over time.  He was signaling that they would let the economy run hot (for an unspecified period of time), letting inflation run above 2%, to make up for the decade of below target inflation.
 
That's happening. 
 
So, is the Fed really hyper-sensitive to this stall just above the inflation target, even if it persists for a while?  Their own formal policy, and history, would suggest the answer is no.
 

Pro Perspectives 12/18/24

 

 

 

 

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December 18, 2024

The Fed cut by a quarter point today, in line with market expectations. 
 
Stocks were crushed.  Yields spiked. The dollar rallied.
 
Let's take a look at the culprit. 
 
 
This is the Fed's latest "SEP" (Summary of Economic Projections).
 
Going in, we expected them to dial UP the 2025 end of year level of the Fed Funds rate, by a quarter point.  They took it up by half a point. 
 
That means they now see two cuts next year, not four.  They see inflation higher now (highlighted in red).  And they see growth a tick higher next year (also in red).
 
Remember, we talked about the Trump effect on the Fed back in 2016.
 
Just a month following the Trump 1.0 election, the pro-growth Trump agenda influenced the Fed to a proactive rate hike in an economy that had averaged only slightly above 1% PCE inflation that year.
 
Also in that December 2016 meeting, the Fed revised UP inflation forecasts, saying “some of the participants” incorporated the “assumption of a change in fiscal policy” into their projections.
 
This time around, they've revised UP growth, inflation and taken two projected Fed rate cuts off of the table (a tightening effect).
 
It probably wasn't a regime change type of day, but Powell acknowledged that it was indeed a "new phase in the process" of finding the neutral level for rates.   
 
When asked if it was because of Trump, Jerome Powell revisited the script from 2016, begrudgingly admitted "some people" did "incorporate effects of policies into their forecasts."
 
Now, today's market reaction reminded me of the shakeout from an inflation report earlier this year (on February 13th).
 
In revisiting my note from that day, indeed we had another rare type of day.
 
Today makes just the fourth time in four years that shared the features of 1) a down greater than 4% Russell 2000 and 2) at least a 14 basis point spike in the 10-year yield.
 

> It happened on February 25, 2021. 

 

What was going on?

 

It was about inflation.  The 10-year yield had risen from 1% to 1.6% in less than a month.  And the move was quickening.  And this quickening was driven by the market's judgement that the additional $2 trillion fiscal package coming down the pike from the new President and his aligned Congress was inflationary at best, and recklessly extravagant, at worst.

 

The $2.2 trillion Cares Act and the additional $900 billion in stimulus passed in December, before Trump's exit, had already driven a nearly full V-shaped economic recovery (by late January '21).  

 

The prospects of more, massive spending packages looked like an inflation bomb.

 

> It happened on June 13, 2022. 

 

What was going on?

 

It was a Monday meltdown, following a hot Friday inflation report. 

 

The Fed had just started tightening and was way behind the curve. 

 

Inflation was near 9%, the Fed Funds rate was below 1%.  With a Fed meeting just days away, the market ratcheted up expectations for an aggressive 75 basis point hike.  And history suggested they needed to take rates a lot higher in order to stop fueling inflation, and start curbing it.

 

So, these two episodes (in 2021 and 2022) were clearly about significant inflation threats — potential runaway inflation. 

 

Now, let's contrast that with the two episodes from this year, which share the features of the 4%+ down day in small caps and the 14 basis point+ spike in yields … 

 

> What happened on February 13, 2024?

 
Remember, heading into 2024, the Fed had telegraphed the beginning of the easing cycle, projecting three rate cuts for the year — while the market was looking for six.  And the Fed then spent the month of January trying to curb the market's enthusiasm about the rate outlook.
 
With that, the inflation data reported that day came in a touch higher … and markets unraveled. 
 
But unlike the two prior market episodes discussed above, the market reaction was unwarranted.  The disinflation trend, at this point, was well intact.  And the inflation data reported was the lowest level of the cycle, and a tenth consecutive lower year-over-year reading.
 
It was an overreaction.  Stocks recovered in two days. 
 
Today's market reaction was, too, about the inflation outlook — but it's inflation that's well into the 2s, in an environment of high productivity, and (still) restrictive monetary policy.
 
So, while inflation is the common theme in these four episodes that share these rare extreme market reactions, it's fair to say the circumstances are quite different in these recent episodes, relative to the inflation backdrop of 2021 and 2022.
 
With that in mind, was the selloff in stocks (and bonds) today an overreaction in a thin holiday market?  It looks that way.

 

Pro Perspectives 12/17/24

 

 

 

 

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December 17, 2024

We get the Fed tomorrow.

As we've discussed, they should do nothing to disrupt the market expectations for a quarter point cut.  

 

As you can see in the chart below, the 2-year yield (the market determined interest rate) tends to be the guide for Fed policy.  It has historically led on the way up, and on the way down. 

 

In the current case, the 2-year is at 4.24% and the Fed is at an effective rate of 4.62% (still 38 basis points higher). 

 
 
That said, the market is expecting a "hawkish cut," where the Fed telegraphs fewer cuts for next year in its Summary of Economic Projections (which is due to be released tomorrow).  
 
As you can see in this table below, coming out of their September meeting, they saw the Fed funds rate at 3.4% level by the end of next year.  They will likely dial that UP by a quarter point tomorrow, which would align with the market view. 
 
 
Let's take a look at the year-to-date performance of the AI Kings (otherwise known as Mag 7). 
 
These stocks now represent 34% of the S&P 500 index.  And with that, they are contributing about 90% of the overall return of the index for the year. 
 
If we look at growth in world money supply since Covid, it's around $20 trillion.  The growth in market value of the AI Kings has been $12.5 trillion over the same period.  Add another $3 trillion in the growth in the value of cryptocurrencies, and it's fair to say that we know where most of the excess money supply (i.e. above trend growth money supply) has been absorbed from the covid response.  

Pro Perspectives 12/16/24

 

 

 

 

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December 16, 2024

In my last note we talked about the synchronized global easing cycle.
 
Major global central banks responded, in coordination, to the global health crisis. 
 
They responded, in coordination, to the subsequent inflation. 
 
And over the past year, they've responded, in coordination, to the disinflationary trend. 
 
So, global policy making has been intentionally synchronized, and that includes Japan — which served a very important role as the global liquidity provider (with QE + negative rates) as the rest of the world was inflation fighting.
 
Now Japan is attempting to "normalize" policy, as the rest of the world is easing.
 
But as we also discussed in my last note, while monetary policy has converged, the economic outlook within this consortium of major central banks/ leading countries has diverged. 
 
And if we simply use consumer and business confidence as our gauge, the divergent economic outlook has come from diverging structural agendas (structural policy). 
 
The U.S. has had a populist political shakeup. 
 
And that catalyst for change has infused confidence in the U.S. economic outlook.
 
 
It's a new roadmap.  And this chart highlights the impact (i.e. divergence in government policy paths = divergence in economic outlook).
 
And as I suggested in my note on Thursday, this divergence doesn't close without a catalyst, and that catalyst might come in the form of a populist political shakeup in Europe.

 
We've seen the Macron government fall in France over the past two weeks.  And just this afternoon, the screws were turned on Scholz in Germany.  He lost a confidence vote.  The Germans will have a snap election likely in late February to determine what might be a new political landscape.
 
And in Canada, Trudeau's government lost two key cabinet members today to resignation (Finance Minister and Housing Minister), and a no confidence vote looks likely early next year. 
 
This is beginning to look like the 2015-2016 populist pushback that delivered Grexit, Brexit and the Trump vote. The people want freedom from the globalist agenda, and they want sovereignty restored.
 
In Europe, if the political dominoes fall in the coming months, it will come with complicated financial risk — a reversion to nationalist governments in Europe would be a clear threat to the future of the euro (the common currency).  
 
 
 

Pro Perspectives 12/12/24

 

 

 

 

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December 12, 2024

On Tuesday, we talked about the Trump effect on the NFIB's Small Business Optimism Index.
 
It was a repeat of 2016.  The spike in the November reading broke a streak of 34 consecutive months UNDER the 50-year average for the index.
 
Also on Tuesday, the Business Roundtable, an association of more than 200 CEOs of America's leading companies, representing every sector of the U.S. economy, released its survey and update to its CEO Economic Outlook Index.
 
This is big corporate America.  And this index spiked too, "above its long-run average for the first time in nine quarters."  Plans for hiring, investing and expectations for sales all jumped.
 
On Monday the New York Fed released a survey of consumer expectations.  This gives us a gauge on how consumers are feeling post-election.  The year-ahead expectations on household financial situation "improved considerably in November." 
 
The share of householders surveyed expecting a better financial situation a year from now rose to its highest level since February of 2020 (just before the pandemic). 
 
This enthusiasm about the economic outlook was clear and on display this morning at the New York Stock Exchange, with a crowd of corporate executives on hand to watch Trump ring the bell to open markets.
 
Now, let's take a look at this chart below of U.S. stocks vs. German stocks and talk about the contrast with what's going on in Europe.
 
 
This chart overlays U.S. and German stocks (S&P 500 and the German Dax). 
 
And as you can see, from October of last year, when Jerome Powell signaled the end of the tightening cycle in the U.S., the two stock markets have tracked closely — on the tailwinds of a synchronized global easing cycle.
 
That said, this morning the European Central Bank cut rates again — now down 100 basis points since April, in response to the disinflation trend.  And by next week, the Fed will likely have taken the Fed Funds rate down by 100 basis points (total) in this easing cycle. 
 
But for the respective stock markets, the economic picture is very different. 
 
The U.S. economy is growing at better than 3% over the past two years.  The eurozone economy is growing at a sub-1% rate over the past six quarters. 
 
And the Trump effect won't work for Europe in the same direction that it's working for the U.S. outlook.   
 
And that said, confidence measures in Europe are 32 consecutive months below the 20-year trend, and with no positive catalyst ahead.
 
 
With this, we should start to see divergence between the performance of U.S. stocks and European stocks, at least until a positive catalyst emerges. 
 
What might that positive catalyst be?  A populist political shakeup in Europe.  

    

Pro Perspectives 12/11/24

 

 

 

 

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December 11, 2024

We had no surprises from the inflation data this morning.
 
With that, as we discussed on Monday, the Fed should do nothing to disrupt market expectations for a quarter point rate cut next week.  But they will almost certainly make significant adjustments in their Summary of Economic Projections (SEP) — reducing expectations on the number of cuts for next year.  
 
Even though the U.S. rate outlook is less "easy" than it was three months ago (following the Fed's 50 bps cut), it's important to remember that this easing cycle (as was the tightening cycle) is synchronized with other major global central banks.  
 
The Bank of Canada cut rates today.  The Swiss National Bank will be cutting tomorrow, and so will the European Central Bank.  It's a global easing cycle. 
 
Add to this, now China is looking to stimulate aggressively next year. 
 
And we should expect China to counter Trump's tariffs with their favorite tool:  a weak yuan (their tool for manipulating economic advantage).
 
In the seven weeks surrounding the 2016 election (early October through late November), the Chinese central bank made the largest seven week devaluation of the yuan since adopting the managed float exchange rate regime back in 2005.
 
This time they will head into Trump 2.0 with the yuan already set at the weakest levels since 2007.      
 
 

Pro Perspectives 12/10/24

 

 
 

 

 

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December 10, 2024

Remember, back in 2016, small business optimism spiked in the weeks that followed the Trump election.

As we discussed last week, we should expect a repeat, especially given that the index that measures small business optimism (by NFIB) was below 2016 levels, having spent 34 consecutive months under the UNDER the 50-year average.

The November report was published this morning, and as you can see, indeed the Trump effect is back for small business.   

This surge in optimism was even bigger than the November 2016 surge, and was described as “clearly” driven by “a major shift in economic policy, particularly tax and regulation, that favors economic growth.”  

Remember, the Fed was influenced by the Trump agenda in 2016, and the related reset in consumer and business attitudes that came with it, so much so that they proactively hiked rates a month after the election, in an economy that had averaged only slightly above 1% PCE inflation that year. 

That won’t be the case this December.  The easing cycle will continue, but it’s a matter of how many more cuts before the Fed goes into a holding pattern, swayed by their perception of potential inflation from what they think is hot growth. 

As we discussed yesterday, the Fed has misjudged the strength of economic output for two consecutive years (an economy which has run at a rate of about 3%).  And they see the long run growth rate for the economy now at less than 2%.

Clearly, they think the below average growth of the past fifteen years is the “new normal.” 

As we observed in my note yesterday, in this chart below, the Fed’s expectations are more than a full percentage point below the long-term average growth of the economy.   

 

With all of this in mind, the Fed is slowly acknowledging that we’re in a productivity boom (likely driven by the technology revolution, generative AI).  We had more data this morning to support that.

And as we’ve discussed often in my daily notes, hot productivity gains promote wage growth, which is needed to reset wages to the increased level of prices (which restores quality of life).  And it can fuel wage growth without stoking inflation. 

And Jerome Powell himself presented back in 2016 at the Peterson Institute (here), that higher productivity growth is a driver of a higher long-term potential growth rate of the economy.

So, they should not be surprised by the current 3%+ GDP growth, and low inflation. 

In fact, with real rates (Fed Funds rate minus PCE) still over 200 basis points, which is historically very restrictive territory (putting downward pressure on the economy), the Fed should be looking to maximize growth.  They should continue to aggressively reduce the ristriction on the economy. 

If we look back at the late 90s boom, which was fueled by a technology revolution (the internet), we were in a productivity boom.  Economic growth averaged 4.5% a year, stocks averaged 26% a year over a five-year period, and inflation averaged just 1.6%.  Still, the Fed was tinkering around with historically high real rates.

But we didn’t have the extent of indebtedness we have today. 

Again, in this high productivity environment, the Fed should be focused on maximizing growth.  Growing the denominator in this chart goes a long way toward solving the debt problem. 

 

Pro Perspectives 12/9/24

 

 

 

 

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December 09, 2024

We get the November inflation report on Wednesday.
 
And we go in, with the market pricing a near certainty of a third consecutive rate cut to be delivered by the Fed next week.
 
That said, the Fed made a considerable effort last week to lower the market confidence on the speed of the easing cycle.
 
Assuming they will do nothing to disrupt market expectations for a December cut, they will certainly make significant adjustments in their Summary of Economic Projections (SEP).
This is how they saw things in September …
 
 
As you can see in this table above, coming out of their September meeting, they saw the Fed funds rate significantly lower by the end of 2025 (highlighted in yellow).  The 3.4% level would be 125 basis points lower than the current level.
 
Since then, as we've discussed, the Trump agenda seems to be influencing the Fed's growth and inflation outlook (higher) — as it did in the weeks following the 2016 election.  
 
Add to that, they've already underestimated 2024 GDP growth by what looks like a full percentage point, just like they did in 2023.
 
There's $3 trillion of excess money still sloshing around the economy (i.e. persistent above trend money supply) and the government is still running crisis-level deficit spending — yet the growth impact is all somehow miscalculated by the Fed. 
 
And then we are in the early stages of a technology revolution, which may be the most productivity enhancing technological advancement of our lifetime.  Productivity growth is a driver of the long-term growth potential of the economy — (that's higher growth, without stoking inflation).
 
With all of this, if you take a look at the orange highlighted number in the table above, the Fed sees long-run GDP growth at only 1.8%.
 
What is the long-term average growth of the economy?  Much higher.   
 

 
Let's talk about some "new news" that could impact the inflation outlook …
 
We've been looking at this chart throughout the inflation cycle …
 
 
 
As you can see, Chinese producer prices led U.S. consumer prices on the way up (and global price pressures), and have led on the way down.  They just reported the 26th consecutive year-over-year deflation in producer prices. 
 
And overnight, for the second time in three months there is news of stimulus to come out of China. 
 
The September announcement gave Chinese markets a jolt, said to be the most aggressive monetary stimulus since the pandemic, which included direct support for the stock market. 
 
This time, it's said to be the biggest monetary policy support since 2010 (depths of the Global Financial Crisis).
 
What did China do with freshly printed yuan back in 2010?  They stockpiled global commodities.    

Pro Perspectives 12/5/24

 

 

 

 

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December 05, 2024

We get the November jobs report tomorrow morning.
 
As a refresher, Jerome Powell maintained the stance in his November press conference that a negative surprise in the labor market was the condition to cut rates faster.
 
This condition has been primarily focused on the rise in the unemployment rate.  
 
They've been most concerned with the speed of the rise, not necessarily the level. 
 
On that note, as you can see below, the peak was July, and we've since had three lower months.  The rise has stalled.
 
 
With that, in the recent commentary from Fed officials we've heard the word "stablized" to describe the unemployment rate.  And Jerome Powell recently said the economy was in "very good shape."
 
Add to that, based on their reaction to the 2016 election, it's fair to say that the Fed is already incorporating policies from the incoming administration into their outlook — policies which should be favorable to the labor market, and boost business confidence.
 
So, it seems likely that this labor market condition/reaction function for the Fed (which amounts to a "Fed put") has diminished at this point.

Pro Perspectives 12/4/24

 

 

 

 

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December 04, 2024

We heard from the Richmond Fed President this morning and then the Fed Chair this afternoon.
 
As we've discussed in recent days, the Fed has lined up speakers this week, with what appears to be an effort to lower the market confidence that a third consecutive rate cut will come when the Fed meets on December 18th.
 
It hasn't worked.  The market is pricing in a 78% chance of a quarter point cut this month.
 
That said, we've talked about the hawkish response the Fed had to the 2016 election, based on assumptions that Trump policies would bolster the growth and inflation path.
 
It's not a stretch to assume the recent election has also influenced the Fed's outlook.  
 
It was mentioned yesterday by Fed Governor Kluger, who said trade policy under the incoming administration may affect prices.
 
And today, at a conference in New York, the Richmond Fed President noted a survey of CFOs, where he said the confidence about growth and the economy were "significantly more optimistic" after the election. 
 
We didn't get much out of the Fed Chair today, other than to say "the economy is in very good shape" and they "could afford to be a little more cautious" in the easing cycle.  
 
What is no longer clear?  
 
With a "picture" Jerome Powell says is stronger now than it was when we they made the 50 basis point rate cut back in September (more stable employment, stronger growth, and a little higher inflation), will they still react, as they've promised in recent months, to any "cracks" in the labor market? 
 
Is the "Fed put" still in play, given the outlook for Trumponomics?
 
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