The holiday-shortened US trading week wasn’t kind to equities.
The world’s benchmark risk asset par excellence headed into Friday afternoon on track for its worst week in 18 months, a near 5% pullback capped by a jobs-day downtrade.
Suffice to say stocks weren’t enamored with the prospect of a decelerating US labor market and a Fed that might be behind the curve.
A lot of the concern appeared to stem from revisions which lopped a combined 86,000 jobs from the June and July NFP headlines. That was enough to overshadow a decent initial read on August jobs growth.
In remarks for a CFR event, John Williams said there’s no “general principle” for whether the Fed “should be gradual” or “move fast” in dialing back policy restriction. It all depends on the data. Although he did indicate an openness to a 50bps first rate cut, it may be too late for stocks. We’re squarely in “bad news is bad news” territory now. The dovish read-through for monetary policy from weak macro data isn’t sufficient to offset recession concerns.
A proactive Fed doesn’t wait until a slowdown’s already afoot (or inflation’s already entrenched) to act. Williams knows that. He’s advocated, in the past, for risk management cuts. The post-Labor Day trade on Wall Street felt quite a bit like the first week of August in the sense that markets are plainly concerned the Fed missed its chance to implement an insurance cut at the July gathering.
Note that the US 2s10s was +6bps on Friday. It was 50bps inverted at the end of June. That seems like a balefully quick dis-inversion, with the caveat that I haven’t run any backtests to determine if, in fact, that’s “too” rapid for risk assets to happily countenance.
“While [an] invert[ed] curve sends a warning ~two years in advance of bad times, disinversion has been a more urgent signal, suggesting trouble is only a few months away,” JPMorgan’s Thomas Salopek and Maggie Zhong wrote, in a Friday afternoon note.
Maybe it’s different this time, but the bank cautioned that sales were “disappointing relative to overall earnings” during Q2 reporting season. “Assuming cost-cutting was the way to achieve numbers, layoffs can enter the picture,” they went on. “[If] the yield curve bull steepens sharply in such a scenario, that will be the true scary signal.”
Chris Waller struck a more emphatic tone than Williams in prepared remarks for an event at Notre Dame. “The balance of risks has shifted toward the employment side of our dual mandate,” Waller said. “The current batch of data no longer requires patience, it requires action.”
He cited the three-month moving average for the NFP headline which, thanks to the above-mentioned revisions, now sits at just 116,000. “[T]hat level is a bit below what I see as the breakeven pace for job creation that absorbs new entrants to the workforce and keeps the unemployment rate constant,” Waller told the audience, on the way to describing the “challenges” associated with determining how to size rate cuts going forward. “Cutting the policy rate at a faster pace means a greater likelihood of achieving a soft landing but at the risk of overshooting on rate cuts if the neutral rate has in fact risen above its pre-pandemic level,” he remarked.
Suffice to say 50bps is on the table for the September meeting. That much, I think, was clear on Friday from Williams and Waller. The concern is that 25bps isn’t going to make any actual difference in the real economy, and it’s entirely possible that August’s 142,000 headline NFP print gets revised lower two weeks after the September policy meeting. A big second revision to the July headline would push that print down towards unchanged. Hawks will argue the November meeting’s right around the corner — that a conservative 25bps cut this month doesn’t risk falling behind the curve. But I’m not sure that’s going to fly with markets which are plainly nervous about the growth outlook.
But — and this is surely a debate the Committee will have — cutting big out of the gate risks spooking markets even further. That’s always the paradox. “Historically, cutting campaigns that begin with 50bps moves are typically reserved for emergency scenarios, a key factor against such a departure point this cycle,” BMO’s Ian Lyngen and Vail Hartman wrote. “Powell’s certainly aware that a half-point cut on September 18 will leave the market wondering ‘what does the Chair know that we don’t?'”
Practically every known macro “recession inbound” warning indicator has been triggered by now. Whether it is yield curve inversion, de-inversion, housing volumes, change in continuing claims, leading indicators, etc. I just finished looking at a slide deck with dozens of time-tested indicators, many I hadn’t heard of. All triggered. Some of these have long and variable lead times to the recessions they have reliably forecasted over the past many decades, others have short lead times. All triggered.
Practically all the current positive macro data can be shown to be unreliable as contra-indicators to inbound recession. Meaning, in the past these data series have sometimes looked fine until suddenly they weren’t.
Many of those inbound recession indicators have been triggered, and thus increasingly wrong, for quarters if not years. And many things in the pandemic and post-pandemic economy and market have not followed historical patterns. Believing in those patterns would have cost a lot of performance over the past few years. Like, career-ending amounts of lost performance.
We seem to be in a stage when investors swing weekly or monthly between extremes of optimism and pessimism. Two datapoints is a trend, three a confirmation, four a funeral – and contrariwise on the flip side.
And, of course, the data and patterns that actually move the market week to week are those from systematics and derivatives – not the macro data.
It is unsatisfying. It is September.
Well put JL.
In the meantime, one satisfying thing is the market rotation, with defensive sectors outperforming and cyclical esp tech underp’ing. It’s a lot easier, in my opinion, to find buyable names in staples, healthcare, utilities than in Mega land.
If the Fed is to be given credit for stopping inflation then it was through aggressive rate hikes and quantitative tightening that began in April 2022. The effect was with a “long and variable lag” that has led us to where we are now. Now the Fed is trying to back the family truckster into the garage with the gas pedal still on “aggressive”. I would argue that the time to begin slowing down was before the car was back in the garage. Being conservative is fine to a point, but it is clear that the lag is over. At this point, I would argue in favor of a 200 basis point cut to remove all restrictiveness to prevent a hard crash into the back wall.
It seems that at least a part of the economy is supported by the AI boom. The primarily players in this space are not affected by interest rates, except if rates go down their earnings drop.
Recently it has been predicted that the new energy economy will gain importance, and industry which is affected by interest rates. Recently AES has indicated starting construction of solar ‘farms’ with robots, this is not the only example of maturing renewable technology. Does this indicate time has come for rapid expansion of the renewable economy?
So is it that lower interest rates at this moment going to set off a stock market rise? Not so much in AI but in energy?
I have been thinking about getting back into renewable names. They have been an awful place. But with AI set to increase electricity demand by some ridiculous amount, and barriers to Chinese products likely to rise, maybe some of these companies can actually make money.
Long green energy if Harris wins, sell if Trump wins.
“The yield curve inversion – I think this one but some people say this one – probably indicates a recession sometime in the next two to three years.”
Nods head approvingly. “Raises for the men.”
I wonder if a 50 wouldn’t kindle some hiring in manufacturing. If they’re trying to play D on trump (which I actually think they have proven they’re not) now is their last chance.