After a series of ten consecutive Fed rate hikes, last month the Fed “skipped” an opportunity to make it eleven.  It was a skip, but not a stop.  Today they raised the Fed Funds rate again, to the highest level since 2001.

As we discussed last month, the decision on the May hike was unanimous, despite plenty of uncertainty surrounding the bank shock (of March).

The June skip was unanimous, though the economic projections from that meeting reflected the Fed’s view of hotter growth and firmer levels of inflation.

And this July hike was unanimous, despite a headline inflation rate that has fallen to 3% — a full percentage point lower than the inflation data available to them the month prior, within which they chose to hold rates steady (unanimously).

In one of the more complicated environments in history, finding eleven (in the case of today’s vote) economists to agree with each other, so consistently, is hard to believe.

But unanimity strengthens the Fed’s ability to manipulate public perception (or as they call it, “guidance”).

And today, with a market that had fully priced in a rate hike, and with unemployment still near record lows, stock markets having resumed flight over the past quarter, and the economy likely growing better than 2%, the Fed, assumingly, thought it could only lose by showing any dissension that might imply a victory on inflation.

Why don’t they want to claim victory?  Because that signal (to consumers, businesses and investors) would be the equivalent of pressing the “gas pedal” on the economy.

And they would be doing so with an economy already positioned to ride tailwinds of big government spending programs, and a technological revolution (in generative AI).

Would a boom-time economy reignite the inflation they’ve been working to get control of?

As you can see in the chart below, the Fed Funds rate is now well ABOVE the inflation rate — as measured by the Fed’s favored inflation gauge, core PCE.

This is historically where the Fed has taken rates to get inflation under control (i.e. above the rate of inflation).  They’ve been there since March.  And this purple line should drop to about 4.2% when we get Friday’s June core PCE report.

So, this dynamic of a positive real interest rate, for the past four months, should be putting downward pressure on inflation.

And it has been. 

Add to this, money supply growth has been the historic driver of inflation.  It soared.  Inflation soared.  It has since contracted sharply as you can see in this next chart.  Inflation has fallen.

As we’ve discussed here in my daily notes, while most of the world has been fighting to get inflation down, the Bank of Japan (BOJ) has been fighting to get inflation UP.

The Western world has faced multi-decade high inflation, and has harmonized a policy response that has included the exit of QE, and key short-term interest rates that are settling in around 5%.

They have done so at a record rate-of-change in policy, and in the face of record high indebtedness.  And in the case of the U.S., with a government that has poured even more fiscal fuel on the fire.

How have they pulled it off, without strangling economies and sending sovereign debt markets into a tailspin (and government borrowing rates soaring)?

Japan.

In cooperation, the Bank of Japan has buffered the effects of Western world tightening by keeping the liquidity pumping from a part of the world that has the most severe structural deflation problem, and the biggest government debt load in the world (Japan).

So rates are still negative in Japan.

And the Bank of Japan is still in full quantitative easing (QE) mode.  In fact, they are in unlimited QE mode.

By the design of their “yield curve control” program, in order to defend the upper limit of the 10-year Japanese government bond yield (which they’ve set at 0.50%), they are forced to buy Japanese bonds in unlimited amounts.  That’s freshly printed money that finds its way into foreign asset markets (like U.S. Treasuries and U.S. stocks).

With that, it’s worth noting that U.S. stocks have done well, in periods over the past year, when this upper limit of the BOJ’s yield curve has been tested.

As you can see in this chart, it’s being tested again …

And this comes as the latest inflation reading in Japan just came in well above their 2% target for the fifteenth consecutive month — which should sustain the upward pressure on the Japanese 10-year yield.

So, given the inflation picture and the pressure that rising global rates are putting on the Japanese bond market, might the BOJ adjust policy at next week’s meeting?

The Prime Minister appears to have quashed that notion today, saying they would “ensure a sustained exit from deflation.”

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Remember, we head into Q2 earnings season with a market that has low expectations — looking for a 7% contraction in S&P 500 earnings.

That sets up for positive surprises. 

With that, let’s take a look at JP Morgan’s report this morning.

Keep in mind, this is the biggest bank in the country.  No entity is closer to the pulse of the consumer, business and government than JP Morgan.

They reported record revenue, and record net income (if we add back the net $1.5 billion they set aside as provisions for credit losses).

Jamie Dimon said, “almost all of our lines of business saw continued growth in the quarter.”

About the economy, Dimon said it continues to be resilient.  Consumer balance sheets remain healthy. Consumers are spending.  And job growth remains strong. 

How is the business customer faring?  Commercial banking revenues grew 14%, just over the past quarter.  

All of this is taking place into the headwind, and at the tail end, of a 500 basis point Fed tightening cycle.  

Bottom line:  The activity at the country’s biggest bank is quite healthy, and that is reflective of an economy that continues to float on a decades worth of money supply growth, that was force-fed over the span of just two years (in response to the pandemic).

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