Pro Perspectives 9/23/24

 

 

 

 

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September 23, 2024

Remember, Jerome Powell told us last week precisely what signal he wants the market to take from the Fed's rate cut. 
 
He said, they don't think they are behind the curve, and that the Fed's "strong move" should be taken "as a sign of [their] commitment not to get behind the curve."
 
Shortly thereafter the governor of the Bank of Japan said the uncertainty around the U.S. economy is the reason for unstable markets.  And he said while soft landing in the U.S. economy remains the base case, "the data since early August has been weak, so risks have heightened somewhat."
 
Keep this all in mind as we consider the comments made by a lineup of Fed speakers since last week's meeting.
 
On Friday, Fed Governor Waller said he would support "big rate cuts" if needed.  If the labor market worsens or inflation data softens quicker, he said he's fine moving in 50s to get to "where they want to go." 
 
"Where they want to go," would be the neutral rate, which is much, much lower. 
 
So, that makes "soft inflation" a condition for him.  And not so coincidentally, he added that he sees inflation coming in soft for August, based on the inputs from the recent PPI and CPI. 
 
Atlanta Fed President Bostic had commentary focused on the labor market.  He says, "if the labor market deteriorates that is a reason for a faster pace to neutral."
 
Chicago Fed President Goolsbee said this:  "Keeping rates at decade-high does not make sense when you want things to stay where they are." 
 
That implies they want things to stay here (2%ish growth, 4.2% unemployment, and very near target on inflation).  If that's the case, the "neutral rate" is where you want to be, to neither stimulate nor restrict economic activity.  And he added, "we are 100s of basis points above the neutral rate." 
 
So, from this commentary (including the Bank of Japan) we can deduce that both the unemployment rate and the (soft) inflation rate sit on thresholds that, if breached, would prompt an aggressive reaction from the Fed. 
 
This all sounds like a Fed that knows they are behind the curve.  They held rates for too high, for too long, which has put the economy in a vulnerable position — though they don't want to admit it publicly.
 
And if we take Powell's guide on this Friday's PCE report, it should come in at 2.2%.  That would be a drop from the July reading of 2.5%.  And that means, by holding rates steady in July (for the twelfth consecutive month), the Fed actually got 30 basis points tighter (more restrictive) in the month of August (i.e. as inflation falls and the Fed Funds rate stays steady, the "real interest rate" moves higher/policy gets tighter).
 
With that, they only accomplished maybe 20 basis points of actual easing out of their policy decision last week.
 
What we do know from all of this is that the Fed wants us to believe, unequivocally, that they are on high alert to protect the economy.
 
That should serve as a perceived safety net for hiring and investing. 
 

Pro Perspectives 9/19/24

 

 
 

 

 

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September 19, 2024

Earlier this year we talked about the parallels between the current environment and the late 90s boom. 

A technology revolution was underway in the late 90s, with the rapid adoption of the internet.  Productivity was high.  Growth was hot.  Inflation was low. And the Fed juiced it with rate cuts, starting in 1995.

The economy went on to average 4.5% quarterly annualized growth through the end of the 90s.  And stocks did this ...

  

 

Also like the current environment, the Fed had real rates (Fed Funds rate minus inflation) at historically high levels heading into the first cut. 

Greenspan cut a quarter point in July of 95, again in December, and then January.  Despite more rate tinkering throughout the period the real rate remained relatively high, as you can see in the chart below .

And as you can see in the far right of the chart, the real rate prior to yesterday’s 50 basis point cut was in the zone of that late 90s boom (i.e. at historically high levels). 

The question:  After yesterday’s move, could the Fed hold real rates here and still get a 90s-type boom-time economy, this time driven by the technology revolution of generative AI?

Growth solves a lot of problems.  But the U.S. debt/gdp has doubled since the late 90s.  And while the debt service/gbp is comparable to the late 90s period at the moment, it won’t be as they continue to refinance at high nominal rates. 

This debt service situation argues that the Powell Fed will have to make deeper cuts than Greenspan did in the mid-90s. 

 

Pro Perspectives 9/18/24

 

 

 

 

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September 18, 2024

The Fed cut rates by half a point today.
 
And they project another half point cut by year end.
 
And it has everything to do with the employment situation. 
 
We've talked for months about the clear "cracks" in the labor market.  And the Fed told us back in March that unexpected weakness in the labor market was a condition for a policy response.
 
And yet they did nothing while watching the unemployment rate rise at a rate-of-change consistent with the past four recessions, and (in each case) consistent with a Fed easing cycle.
 
So they come in today, not with just a cut, but a large cut, and projecting another 50 by year end, and another 100 basis points by the end of next year.
 
What signal should the market take from this?
 
We don't have to guess.  Jerome Powell told us what signal he wants the market to take from this.  He said, they don't think they are behind the curve, and that this "strong move" should be taken "as a sign of our commitment not to get behind the curve."
 
Translation: If the job market deteriorates further, he says "we have the ability to react to that by cutting faster." 
 
So, how did markets respond?
 
It should have been stocks up, yields down, commodities up, dollar down.
 
What happened?  
 
Stocks:  Up first, then down. 
 
Yields: Down first, then up. 
 
Commodities:  Up first, then down. 
 
The dollar:  Down first, then up.  
 
This outcome for markets, by end of day, was the opposite of what you might expect for a Fed move that lightened the brake pressure on the economy, and with plenty of promises that they will do what it takes — that they are "committed to a good outcome" (i.e. stabilizing the labor market and averting an economic downturn).
 
This odd market behavior brings us back to my July 31 note, just following the Fed's last meeting. 
 
Given the Fed's reluctance to move in that July meeting, despite the obvious drag that rates were having on the economy, and the clear weakness that had developed in the labor market, I asked:  Are they not moving because they are worried about the dollar (i.e. preserving global capital flows to protect the dollar)? 
 
As we now know, the sharp unwind of the carry trade accelerated the next day, leading to a sharp drop in the dollar.  It was only stabilized by verbal (and likely actual) intervention from the Bank of Japan.
 
Today's Fed news was clearly dollar bearish. Yet, the dollar went up.
 
Are the Fed and the Bank of Japan coordinating to maintain stable markets?  Likely.    

Pro Perspectives 9/17/24

 

 
 

 

 

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September 17, 2024

With the Fed due to officially kick off an easing cycle tomorrow they will do so well behind the curve, with the Fed Funds rate sitting 283 basis points ABOVE the rate of inflation (PCE).

But the interest rate market has already determined where rates should be.

Since Jerome Powell signaled the end of the tightening cycle in October of last year, the 10-year yield (the market determined interest rate) has fallen by 140 basis points.

Moreover, with the even sharper plunge in the 2-year yield (down 166 basis points since last October) the yield curve has returned to a positive slope, after two years of inversion.

And as we’ve discussed here in my daily notes, yield curve inversions are historically predictors of recession.

And when the curve turns positive again, it tends to indicate an economy has either entered or is about to enter recession.

That said, while market interest rates have adjusted, consumer interest rates have been slow to follow.

The average 30-year fixed mortgage rate is now at 6.2%.  If we look back at the historical spread between mortgages and the 10-year yield, it should be closer to 5.4% (or lower). 

 

Average credit cards rates are 17 percentage points above the 10-year yield.  It’s historically closer to a spread of 10. 

Auto rates?  Those are running about 300 basis points above the long run average spread to the 10-year.

Maybe these spreads will finally start narrowing when the Fed proves tomorrow that it will indeed kick off the easing cycle, after a lot of talk.  

 

Pro Perspectives 9/16/24

 

 

 

 

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September 16, 2024

The Fed will cut rates on Wednesday.
By how much, probably has more to do with preserving global financial stability than preserving labor market stability (at least for the moment).
 
On the latter, this first rate cut will come in reaction to "cracks" in the labor market that have developed as a result of the Fed holding real rates (the Fed Funds Rate minus the inflation rate) too high, for too long.  
 
So, the Fed wants to stabilize the employment situation.
 
And it has a lot of room to cut/ to stimulate. 
 
In fact, as you can see in the chart below, they could cut by more than 200 basis points to get to the level they deem to be "neutral" (not stimulative nor restrictive).   
 
 
Of course, a huge slash of rates won't happen.   
 
Why? 
 
As the Fed (and the world) discovered early last month, the prospect of rates moving lower in the U.S., while rates are simultaneously moving higher in Japan (as Japan is exiting its emergency level policies that have supported global markets the past two years), presents a shock risk to global liquidity and global financial stability. 
 
How did the market react last month?  A massive spike in the VIX and a three-day loss in the Nikkei (Japanese stocks) comparable to only three other periods over the past thirty years:  the darkest days of the Global Financial Crisis, the tsunami and the Covid lockdown.
 
So, both the Fed and Bank of Japan will again determine policy this week.  We should expect the Bank of Japan to hold the line (do nothing to incite a market reaction). 
 
But the Fed will cut. 
 
And whether or not the Fed will trigger a negative reaction across global markets will likely have to do with: 1) how big of cut, and 2) how they manage expectations on the speed and depth of future cuts.
 
With that, the market is now leaning toward 50 basis points.  We've heard a former Fed governor calling for 50.  Elizabeth Warren, the Senator from Massachusetts wrote a letter to the Fed today calling for a 75 basis point cut.  
 
Given the shock risk, my bet is on 25, and a Fed that positions the cuts as just "reducing restriction" and maintaining focus on the inflation fight.
 
In line with that view, the Bank for International Settlements (the "BIS," a consortium of the world's top central banks) published a well-timed report today, urging central bankers not to "squander" the interest rate buffers they have built over the past couple of years by cutting too rapidly.   
 

Pro Perspectives 9/11/24

 

 

 

 

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September 11, 2024

Going into this morning's inflation report, markets looked vulnerable. 
 
As we discussed yesterday, the bond market has been telling us the Fed is way behind the curve — too slow to recognize the deterioration in the job market (and the economy). 
 
Oil prices have been falling, sending a negative signal on the demand outlook.
And this chart below, we've been watching, was projecting more downside for the Nasdaq/big tech stocks. 
 
 
Remember, this is the chart of the dollar/yen exchange rate in purple, and the Nasdaq in orange.
 
The two have tracked closely resulting from the flow of global capital driven by the "yen carry trade" (i.e. borrowing Japanese yen effectively for free, converting that yen to dollars, and investing those dollars in the highest quality dollar-denominated assets).
 
But as we've discussed over the past month, the prospects of rate cuts to come from the Fed, combined with tightening policy in Japan, have triggered a reversal of the yen carry trade — out of dollars and dollar-denominated assets, and back into the yen.  
 
So, the inflation data this morning was the final catalyst heading into what will be the Fed's first rate cut next week.  And with no surprise in the inflation picture, it seemed clear that the continuation of the reversal of the yen carry trade would ensue.
 
Indeed, the morning started with aggressive selling in stocks.  But at 11am EST, it all reversed — stocks, commodities, yields, bitcoin … everything.
 
What happened?  Commentary hit the wires from the founder/CEO of the most important company in the world.  Jensen Huang took the stage at a Goldman Sachs tech conference.  And he said the demand for the new Blackwell chip is "so great … everybody wants to be first, and everybody wants to be most." 
 
Did this turn markets?  Maybe.  But it's nothing new.  
 
If we look back at Nvidia's August earnings, we already know demand is insatiable. 
 
It's the rapid design cadence in accelerated computing and supply constraints that have capped Nvidia's growth capacity (at least at this point) — at a trend of $4 billion of new revenue a quarter.  And if that trend continues, the year-over-year growth rate for Nvidia will be cut in half by this time next year (to something closer to 50%, from triple digits).  

 

Pro Perspectives 9/10/24

 

 
 

 

 

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September 10, 2024

As we discussed last week, the Fed specifically went after jobs as the mechanism to bring down demand, and therefore bring down inflation from multi-decade highs.

The question is, did it come at the expense of an economic recession?

There are signals flashing.

Take a look at the 2-year yield …

 

The 2-year is now down more than 80 basis points from late July.

That’s 175 basis points lower than the Fed Funds rate.  The bond market is telling us the Fed is way behind the curve — too slow to recognize the deterioration in the job market (and the economy).

So, the front end of the yield curve has collapsed, and the yield curve is now positive sloping, after two years of inversion.

Yield curve inversions are historically predictors of recession.

When the curve turns positive again, it tends to indicate an economy has either entered or is about to enter recession.

What else is flashing a warning signal?

Oil.

Oil is down 13% in seven days, trading near the lows of the past three years.  The last time we had a seven-day decline of that magnitude was March of 2023, surrounding the bank shock.

Of course, the bank shock was cleaned up with more central bank intervention.  Similarly, the recent carry trade shock was, at the very least, curbed through verbal intervention (by the Bank of Japan).

So, we have some signals flashing in a world where central banks have made a habit of cancelling market signals.

 

Pro Perspectives 9/9/24

 

 

 

 

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September 09, 2024

Friday's jobs report came with downward revisions, yet again.
 
As we discussed late last month, over the past three years the Biden Bureau of Labor Statistics (BLS) has consistently reported jobs data in a way that has led to very consequential misreads on the health of the economy by policymakers.
 
In 2021, the initial monthly reports from the BLS UNDER reported job creation by 1.9 million jobs for the full year.  The BLS ultimately revised UP eleven of the twelve months.
 
The economy was a lot hotter than the Fed thought.  Inflation ran wild, and the Fed was behind the curve. 
 
In 2023, the initial monthly reports from the BLS OVER reported job creation by what was initially thought to be 360k jobs.  Not only did they end up revising DOWN ten of the twelve months of payroll numbers, but they also followed with a huge one-off downward adjustment to the job picture for much of that period (818k fewer jobs than initially reported for twelve months through March 2024).
 
That brings us to Friday.  August job creation came in 20k fewer than expected, and came with news of 86k fewer jobs (as revised down) from the previous two month reports.
 
So, the unreliable BLS reporting on jobs first led the Fed to hold policy too easy for too long, fueling historic inflation.  Now, the risk is growing that the unreliable BLS reporting (in the opposite direction) may have led the Fed to hold policy too tight, for too long.
 
On that note, remember the Fed Chair himself has told us numerous times over the past year, that if they wait for inflation to get to two percent before they start cutting, "it would be too late." 
 
Too late means overshooting to the downside.  And overshooting to the downside means putting deflation risk back on the table.
 
With that, we get CPI on Wednesday.  It's expected to come in at 2.6% (the headline number).
 
What if we get a downside surprise on inflation?  
 
Clearly that would have been celebrated a few months ago.  But now, given the deterioration in the jobs picture, a downside surprise in the inflation data would further signal that the Fed is behind the curve — they've miscalculated.    
 
What are some clues on Wednesday's report? 
 
If we look to China and the input prices on many of the products we buy, the recent producer prices report shows input prices have fallen now for nine of the past ten months, and year-over-year prices have been in deflationary territory for 23 consecutive months.
 
As for direct inputs into U.S. CPI, the biggest contributor to the sharp fall in U.S. inflation from 9% to under 3% has been energy prices.  So, if we look at the price records from the EIA for August (Energy Information Administration), oil was down 6%, retail gas prices were down 12%, and natural gas was down 23% (all for the same period a year ago). 
 

Pro Perspectives 9/5/24

 

 
 

 

 

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September 05, 2024

We get the August jobs report tomorrow.

What’s the one thing the Fed has threatened, dating back to March?

Jobs.

With that, over the course of this tightening cycle, negative surprises in the jobs report have been a positive catalyst for stocks.

Why? 

Because the weaker picture on jobs served as a signal that perhaps the exuberance was lifting in the economy, that the leverage for job seekers to negotiate higher wages might be abating, and therefore the backdrop for cooling inflation was forming (according to the Fed’s plan).  And the progression of that formula suggested the Fed’s inflation fighting campaign could come to an end, if not reverse.

So bad news was good news. 

Fast forward two-and-a-half years, and negative surprises in what has been deteriorating jobs data is no longer good news. 

Bad news is bad news.  

Why? 

With the inflation rate having normalized and economic growth arguably running below potential (given all of the fiscal spending), a rapidly rising unemployment rate may mean the Fed held its foot on the brake for too long — and that damage has been done to the economy. 

This all confirms the end of the inflation fight, and puts the Fed in an easing stance, but markets will want to see a Fed response that’s aggressive enough to stabilize jobs and economic conditions.

With the above in mind, stocks are already down 2.5% for the month of September, heading into tomorrow’s number.

This big trendline we’ve been watching in stocks dates back to October of last year, when Jerome Powell signaled the end of the tightening cycle. 

As you can see, this line broke on August 2nd on the weak jobs report last month.  And here we are again, after the V-shaped recovery of that sharp decline last month — stocks are back below this line heading into tomorrow’s number.

Add to all of this, the dynamics that exacerbated the selling in stocks in early August remain today (i.e. prospective monetary policy divergence between the Bank of Japan and the Fed — which reduces incentives in the carry trade).  

And there may be some seasonal influence on stocks here too.  Let’s take a look at the past four Septembers (2023, 2022, 2021, 2020).

September 2023 (S&P) was down 5%.  

September 2022 was down 9%.

September 2021 was down almost 5%. 

September 2020 was down almost 4%.

That’s the bad news.  Here’s the good news. 

Each of these bad Septembers was followed by a good fourth quarter. 

Fourth quarter 2023 (S&P) was up 11%.

Fourth quarter 2022 was up 8%.

Fourth quarter 2021 was up 12%.

Fourth quarter 2020 was up 12%.

 

Pro Perspectives 9/4/24

 

 

 

 

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September 04, 2024

As we head into Friday's August jobs report, we had another signal today that the labor market has chilled. 
 
The job openings data (JOLTS) this morning kicked off what should be a series of soft employment data through Friday.
 
The JOLTS report is of particular interest because Jay Powell specifically isolated this data point early in the tightening cycle.
 
After the first rate hike in March of 2022, he launched a verbal attack on demand, and when asked what mechanisms he would use to reduce demand, he said this:  
"If you look at today's labor market, what you have is 1.7-plus job openings for every unemployed person.  So that's a very, very tight labor market — tight to an unhealthy level…. We're trying to better align demand and supply, let's just say in the labor market.  So, if you were just moving down the number of job openings so that they were more like one to one, you would have less upward pressure on wages [and] you would have a lot less of a labor shortage" … "and that, over time, should bring inflation down."
So, where does today's report leave us?  1.07 job openings for every 1 job seeker.  
 
 
So, the Fed has achieved its goal. 
 
The question is, will it come at the expense of an economic recession?
 
It seems likely. 
 
As we've discussed, for the past fifteen months through July the unemployment rate is up 9/10ths of a point above the cycle low (3.4%).  The speed of this change in joblessness puts it in the unique company of the past four recessions (which came with, in each case, reactionary Fed rate cuts).
 
And the 2-year yield is now 159 basis points lower than the Fed Funds rate.  The bond market is telling us the Fed is way behind the curve — too slow to recognize the deterioration in the job market (and the economy).
 
With the plunge in the 2-year yield over the past month (down 65 basis points since July 31), the yield curve is nearing a return to a positive slope, after two years of inversion.  
 
 
Yield curve inversions are historically predictors of recession.
 
When the curve turns positive again, it tends to indicate an economy has either entered or is about to enter recession.
 
On that note, remember, during their respective tenures as Fed Chair, both Bernanke and Yellen said that economic expansions don't die of old age, the Fed tends to murder them.