Jeff Gundlach thinks it’s likely the Fed will be compelled to abandon their “higher for longer” pretensions.
“I predict the Federal Reserve will be cutting rates substantially soon,” he said this week, adding that, “I am wrong about 30% of the time, so factor that into any decision making.”
If Gundlach is in on his own joke, it’s never been obvious. It’s easy to satirize his remarks, and I used to indulge at regular intervals. Telling nearly 300,000 social media followers that you’re wrong 30% of the time is tantamount to telling them you’re right seven times out of 10. Gundlach was attempting an humblebrag, but a master of subtlety Jeff most assuredly isn’t.
Anyway, the market generally agrees. During this week’s press conference, Jerome Powell attempted to dispense with the notion that rate cuts are likely this year (in light of the bank drama), largely to no avail.
Markets would be inclined to expect policy accommodation under the current conditions anyway, but when you factor in the potential for the inevitable credit contraction at regional banks to amplify what was already a fairly acute trend towards tighter lending standards, bets on rate cuts aren’t unreasonable.
It’s really more about whether traders are overzealous in that regard (i.e., expecting too much, too soon).
“Cumulatively, [the bank crisis] is not only adding to the increased market pricing of an accelerated Fed policy capitulation from tightening to easing, but even going so far as to price small delta of an April inter-meeting cut,” Nomura’s Charlie McElligott wrote Friday.
“I can kinda back into a May FF pricing which looks a bit like ~50% ‘Pause,’ 35% ‘Hike 25bps’ and 15% ‘Cut 50bps,'” he added.
Although I’d instinctually be inclined to say “Absolutely, yes,” if the question is whether easing bets are overblown (look how overblown the late-February / very-early-March tightening assumptions turned out to be!), I’ll concede that the bank crisis has made Larry Summers’s “Wile E. Coyote” thesis much more likely.
If there is indeed a Wile E. Coyote moment for the economy that entails a sudden drop in spending, it’ll be followed swiftly by a Fed pivot on the assumption that America’s inflationary demand “problem” has been solved by bank runs — a suboptimal solution, to be sure, but a solution nevertheless.
But, that latter assumption may not be entirely correct. The consumption habit ingrained in America’s legions of dedicated spendthrifts could prove hard to break, for example. If the Fed pauses but the economy doesn’t roll over and the inflationary impulse sticks around as a result, it’s worth noting that a strategy which entails buying risk assets immediately once the Fed confirms the end of the hiking cycle may not work if the macro regime shift witnessed over the past two years proves durable.
“‘Sell the last hike’ was the correct strategy for stocks in the inflationary ’70s/’80s rather than ‘buy the last hike,’ which worked in the more recent disinflationary market of ’90s+,” BofA’s Michael Hartnett noted.
I haven’t fact-checked the table on the right. I assume (I hope) I don’t have to. As Hartnett went on, “stocks fell in the three months after every last hike in the ’70s/’80s.”
If you ask BofA (or at least if you ask Hartnett), the same is likely to be true this year. “[The] negative feedback loop from higher unemployment to day traders, retail, consumers and corporations is likely to be very pronounced,” he said.
Once the dominos fall, where in this case that means tighter local lending standards, a further deterioration in small business sentiment (which has been abysmal for more than a year, by the way), a spike in jobless claims and an eventual negative monthly NFP print, equities will probably stage a “final lurch lower,” Hartnett went on. That’s the trough to buy, he suggested.
But if (or when) that occurs, BofA wouldn’t be indiscriminate. “We want to buy… secular leadership of inflationary cyclicals, not the old leadership of credit, PE and large-cap tech,” the bank said.
Powell just raised rates. He is all in that the economy is going to continue to grow slowly and that he can softly land the economy into a no growth or very mild and short recessioni. The market including gundlach is implicitly saying otherwise. I’m with JG.
RIA! How in heaven’s name can you shrug off Jim Bullard’s sacred models?
Please give some examples of what sectors qualify as “inflationary cyclicals”. Do we include banks ?
I was stumped too on ‘inflationary cyclicals’ … so I asked bing/chat: “Inflationary cyclical refers to a category that has a negative and statistically significant relationship between the unemployment gap and its inflation rate. If this relationship is not negative, then it is considered acyclical1.” Examples off top head anyone?
Summarizing and paraphrasing openai’s beta (which is chatgpt4):
Things that grow slow even when there’s a downturn (and are often but not always necessities that have pricing power)…
Energy
Materials
Industrials (manufacturing)
Financials (if able to pass on higher rates)
Consumer Discretionary (luxury)
“there are always risks and uncertainties associated with investing… etc etc etc “
I would love to see more color around the lousy small biz sentiment. Is it because demand has been softening or, as I suspect, because cost inflation is sticky and workers hard to find? I’m in NE Ohio this week, in a pretty affluent suburb of Akron, and this morning the newish big-city-style coffeehouse was filled to the rafters; next door, an even newer breakfast/lunch place (opened by the coffeehouse owner) was also packed and had Help Wanted signs posted everywhere. A single data point, yes, but would suggest that any slackening in demand for services has yet to happen.
Inverted yield curves reliably predict recessions, because – in my view – the inversion stresses and breaks all sorts of carry trades that depend on “normal” positive yield curves, thus helping cause the recessions they predict.
The predictive relationship is inarguable, but bulls can point to the long and variable lag from inversion to recession to argue that the music hasn’t stopped playing yet.
When inverted curves start de-inverting, the typical lag to recession is shorter. The music is slowing, soon some of us will be without seats.
MFN, here’s my personal take, as a small business owner.
• supply interruptions, while not as acute, are still occasionally frustrating and time consuming
• profit margins continue to be squeezed. I’ve maintained pricing, outside of increases in the goods I’m buying (I’m in the liquor business with small comparative margins to begin with, so anytime an item comes in at a higher wholesale cost, the price adjusts accordingly). But I’m exhausted from losing cashflow battles, so now almost everything in the stores will be looked at for price increase.
• Comp sales against prior year are down and have been for a while. While they may have been inflated during the massive wfh days, seeing red percentages instead of green doesn’t make for warm, fuzzy feelings.
• Wage increases loom constantly. I’ve been fortunate to not have suffered badly from understaffing, but there’s still plenty of worry about retention if I can’t keep increasing hourly wages.
• I’m growing my empire by expanding into new stores and ventures, but increasing cost of capital is (of course) already slowing me down. (Anyone looking for someone to invest some equity in? Lol)
• The increasing disparity in economic trends is time consuming to deal with. For my business: are people still spending to go out, or are they ready to limit that and go back to dining at home? Trading down in price almost seemed to come back, but not really. Trading up was rampant, but maybe coming back off one moment, but no, still going strong. Predictability’s return would be appreciated.
Your Ohio coffeeshop story is spot on: economy is growing, pre-pandemic boom areas are back to booming, expansion opportunities abound. On the other side, all of the extra work isn’t bringing extra reward as costs rise, as debt interest rises, as an unexpected quick turn in sales deflates growth, and as wages and worker scarcity consumes time and energy.
I suppose that these are all issues that have always been faced by SMB owners, but it sure feels like the winds change too frequently these days.
H-Man, great piece. I am in the down lurcher camp.
Recently I wrote here that it was time (or near time) to pause. Realistically, I think it is near. But what’s going to happen with the masses of money sloshing around at the top of the economy?
The tax on the 0.1% that Biden keeps talking about needs to happen. Trumps 2017 tax giveaway to the wealthiest of the wealthy needs to be proposed and passed. Is there more money in the economy than the Fed can pretend to manage? There are limits to the power of the Fed to check overly enthusiastic buyers as the pause comes upon us. They know it. And we all know it.
As Walt has noted, there’s an uncomfortable (to me) persistent level of inflation in the economy, even though real income for regular working people is down. His citation of Harnett words ring true to me, that the dominos will fall.
I was among those who bought on the last hike in the 90s. We’ll see what effect the masses of money have on inflation in coming months. But it feels to me like Indianapolis on Memorial Day weekend. The market will do what it does: It is going to race like hell when the flag comes down.
I think we are on the cusp of a (semi?)wartime inflationary pivot. Russia and China are either threatening to (Russia) or already into (China) a huge military buildup. As usual we are late getting started but at least we are acknowledging that we have to pick up the pace. Critical materials mining and processing, hypersonic planes and missiles, newage weapons. all on he back of a the equally serious climate crisis and it’s required attention. All will help keep employment and the economy moving forward. All inflationary? Probably. Do we have a choice? Probably not. Will we revamp the education system to meet the requirements? Probably not? Will we pay a hefty price for the inaction. Absolutely.