This Ain’t Over: Macro Discomfort Returns For The Holidays

Muted markets and subdued sentiment looked more like visible discomfort by noon on Wall Street Tuesday. The bad vibes persisted into the close.

Idle recession chatter from Jamie Dimon and David Solomon didn’t help, but it’s probably more apt to suggest markets are again grappling with the reality that this ain’t over, to lapse briefly into colloquialisms.

“This” means the frustrating macro and policy conjuncture that made 2022 such a woeful year for assets of all sorts. Between the very hot read on wage growth that accompanied Friday’s jobs report and Monday’s upside ISM services surprise, market participants were again reminded that the labor market is tight and the US economy resilient. As such, true inflation relief remains a distant prospect.

While acknowledging the possibility that, with the benefit of full data revisions and hindsight, the NBER may one day date the onset of recession to early 2023 or even to this quarter, as far as anyone knows right now the US isn’t in a recession. That means the Fed is likely to plow ahead, raising the stakes for the downturn once it finally rolls around.

That latter bit of nuance is key, and it was captured Tuesday by Nomura’s Charlie McElligott, who wrote the following:

Both the stock and bond markets would prefer a ‘rip-off-the-Band-Aid’ quick move into recession (which is where consensus ’23 has already been), as a linear slowing in growth would match a parallel downshift across inflation, labor and wages, allow[ing] for a shorter stay in this final ‘run restrictive’ phase of the Fed cycle, and simultaneously, a faster turn into Fed easing thereafter.

But with services data and labor remaining so resilient at this juncture, it instead reintroduces that ‘run more restrictive’ / ‘higher rates for longer’ risk, which then increases the likelihood of an over-tightening left-tail accident / harder slowdown [that] ultimately cracks stretched consumers already leaning on credit with their savings evaporating. [That] then points to the ‘earnings recession’ scenario keep[ing] so many bearish.

As ever, I applaud Charlie for his ability to editorialize around the real-time evolution of the macro narrative while simultaneously documenting all manner of market structure arcana. It’s rare that strategists are fluent, let alone proficient, in both the macro and the arcana.

One crucial takeaway is that the longer it takes for Main Street to succumb now, the higher the risk that the eventual downturn will be severe as opposed to mild. That’s because a Fed forced to run very restrictive policy in what’ll feel like perpetuity if they try to hold terminal for as long as the December dots are likely to indicate, is a Fed that risks an outright reckoning in the real economy, characterized by a deep correction in home prices (as job losses and other unfortunate “life events” characteristic of severe recessions force home sales and still-high rates keep buyers at bay) and meaningful consumer retrenchment amid layoffs and the squeeze from variable-rate debt burdens.

In such a scenario, corporates already coping with rising labor bills, still elevated input costs and barely-healed supply chains, could see lower sales, meaning both the top and bottom lines get crimped. That’s when it all falls apart.

Just Monday, we learned that Pepsi is laying off “hundreds” of workers, and late last week, reports indicated Wells Fargo continues to trim positions in its mortgage business. The Wall Street Journal, which originally reported the planned cuts in Pepsi’s North American snacks and beverages divisions, called the decision “a signal that corporate belt-tightening is extending beyond tech and media.”

For its part, Wells Fargo explained the decision to further reduce headcount among mortgage employees by citing “regular review[s] and adjust[ments] to align with market conditions and the needs of our businesses.” That was surely meant to make the cuts seem routine, but it only underscored the scope of the housing malaise.

That sort of thing is going to continue for the foreseeable future. The risk, as McElligott correctly pointed out, is that the downturn is more slow motion train wreck than linear drop off. The longer this takes to materialize, the more painful it’s likely to be given that a slow deceleration in growth and a gradual softening in the labor market set against still elevated services sector inflation won’t give the Fed the plausible deniability it needs to pivot decisively.

“You have to assume that we have some bumpy times ahead,” Goldman’s Solomon told Bloomberg Tuesday. “You have to be a little more cautious with your financial resources, with your sizing and footprint of the organization.”

Last week, Goldman’s traders learned that despite bringing in the most money in a decade for the firm, the bonus pool was set to shrink by “a low double-digit percentage.” On Tuesday afternoon, CNBC said Morgan Stanley cut 2% of its staff, impacting about 1,600 employees.

Unlike 2021, defecting to the crypto industry isn’t an especially palatable option for aggrieved Wall Streeters.