June payrolls is being billed as the pivotal data point when it comes to cementing the case for a July rate cut, and maybe it is, but you’d be forgiven for thinking the die is already cast.
It would likely take a monumental beat on the headline print and a much hotter-than-expected average hourly earnings number to force the Fed to consider disappointing markets that are all but sure about a July cut (the debate about 25bp or 50 is a separate issue).
Even if the number is a blockbuster, the evidence is mounting that the US economy is cracking. ISM manufacturing sits at the lowest of the Trump presidency, the non-manufacturing gauge came in weak, MNI’s Chicago barometer is in contraction territory, Empire manufacturing dove the most on record recently and on and on. It would hardly be surprising to see the US finally succumb given the length of the expansion and the deepening global factory slump.
Still, the labor market could hold up. “The likelihood that unemployment rates in developed markets shoot higher because of weak manufacturing and trade growth is low, in our view”, Credit Suisse wrote Tuesday, adding that “in recent decades non-recessionary IP slumps have been common” and while they have “typically generated widespread economic pessimism, large market moves, and central bank reactions” they haven’t precipitated big moves in unemployment. “An important question now is ‘Is this another one of those?'”, the bank says.
But it’s not just the global factory slump and trade jitters that are clouding the outlook. The bond market is screaming something, it’s just that, thanks to questions about the reliability of the yield curve in an era of depressed term premiums and experimental monetary policy, nobody knows quite sure what.
What we do know is that if history is any guide, problems may be right around the corner. “The last time the whole US curve was inverted in this way and a recession didn’t follow, was in 1986, when the bond market rally was led by a very sharp fall in oil prices as OPEC output increased by around 25%”, SocGen’s Kit Juckes wrote Thursday.
Juckes continued, noting that “there are plenty of reasons to be skeptical about whether the curve is now a good indicator of where the economy is going, but the debate about the economic outlook will rage on [and] we think the sun is slowly setting on this cycle, even if the evidence is likely to remain mixed.”
None of these concerns have stopped stocks. Coming off the holiday, the S&P is riding a five-day win streak and futures briefly topped 3,000.
The question Friday is whether the “good news is bad news” regime is now so entrenched, that a decent jobs report would be greeted with jeers from risk assets on the assumption it reduces the odds that the Fed will deliver later this month.
The worry for the Fed, meanwhile, is that policy has now become what Bernanke described as a “hall of mirrors”.
If the market prices in a rate cut and the Fed assumes the market is “smart” and thereby delivers, it could set in motion a self-fulfilling prophecy. Goldman touched on this last week. If the Fed cuts, “the bond market might immediately price a higher probability of subsequent cuts, reflecting the assumption grounded in past experience that there is momentum in monetary policy decisions—the probability of cutting, for example, is higher conditional on having cut last time”, the bank wrote a week ago, adding that the bond market might then “interpret the cut as evidence that the Fed is worried about the growth outlook” and if “market participants view the Fed as having private information about the economy they might grow more pessimistic themselves”.
Of course, if the market is pricing in rate cuts and you don’t deliver, that’s a hawkish surprise and it risks tightening financial conditions.
Welcome to policymaker hell.