One of the main takeaways from last week’s Fed meeting was how forceful Powell was that the election will not influence the Fed’s decisions. I take this as good news. About a month ago I highlighted how binary the ultimate number of cuts could be: 5 if they start in the summer, 1 if they wait until after the election. It was the crankiest I can remember him being answering a question, which tells me he really believes it.
What he says might matter even more than I realized. Bloomberg came out recently with a genAI model that tracks Fed-speak hawkish/dovish sentiment. One of the most fascinating takeaways from the article is that the Powell Pivot in December helped the US avoid a recession.
Think about the Goldilocks dilemma Powell faces. Too dovish and things reaccelerate. Too hawkish, we have a recession (although most in real estate would probably welcome this at this point).
Question from one of the guys in that sits in the back row at class – if we avoided a recession only because the market got hyped about a lot of rate cuts, doesn’t that imply the economy is closer to being fragile than to overheating?
This Week
- 10T: 4.50%
- German Bund: 2.49%
- 2T: 4.81%
- SOFR: 5.31%
- Term SOFR: 5.32%
- Jobs data was a miss
10 Year Treasury – QT Tapering
Powell’s dovish tone was the headline from the FOMC meeting, but one of the more overlooked aspects was the tapering of QT. The 10T has been rangebound for a while now, mostly dependent on data that leads to more/less cuts. I say “mostly” because the slowing pace of QT that was announced should help alleviate some upward pressure on yields. That’s not the same as applying downward pressure, but it’s a start.
Here’s an overly simplistic explanation of how tapering QT can allow the 10T to drift lower. And don’t ask for a more sophisticated explanation because I don’t have it. Also, the plural of a single Treasury bond is Treasurys, not Treasuries, so save your hate mail over my spelling.
Let’s start with Quantitative Easing (QE)
- The Treasury issues Treasurys
- Banks buy Treasurys
- The Fed buys the Treasurys from the banks
- The banks now have lots of cash…too much cash if QE goes on long enough…aka excess reserves
- The banks need to put the cash somewhere, so they park it at the Fed’s overnight reverse repo facility where it can earn interest
- The Fed becomes the biggest owner of Treasurys by gobbling them up from banks and banks end up with a ton of cash…which gets deposited back at the Fed…because that’s how the system works and don’t you dare question it because it’s too complex for you to understand and just leave it to the professionals
TLDR: QE causes rates to go down because of the massive buying of Treasurys by the Fed
Now let’s turn to Quantitative Tightening (QT)
- The Fed allows bonds it already holds to mature (in fancy finance terms, “roll off”)
- The Treasury repays the bond principal to the Fed with cash - In order to pay the Fed cash, the Treasury has to issue new Treasurys to raise cash
- Banks buy these newly issued Treasurys
- But the Fed doesn’t buy these Treasurys anymore, so the banks experience a drop in their cash
- This process continues to play out over time, draining liquidity from the system
TLDR: QT puts upward pressure on yields since the Fed is no longer a buyer at any price
And finally, mercifully, Tapering of QT
- The Fed has been allowing up to $60B in Treasurys to roll off each month for the last two years
- Last week, this pace was announced it will slow to $25B per month
- The intent is to avoid a repeat of the money market seizure experienced in 2019 (when FF popped north of 10% in one day) by creating a liquidity crisis
- But one byproduct could be lower Treasury yields
This graph illustrates the balances kept at the Fed’s overnight reverse repo facility (blue and white) and the 10T (red).
- The reduction in liquidity has helped apply upward pressure on yields
There are a lot of reasons the T10 has been testing 4.75%, so the tapering of QT won’t cause the bottom to fall out. But it removes one obstacle from lower yields if data comes in weaker than expected. Speaking of data coming in weaker than expected…
Jobs
The best news from Friday’s jobs report was that average hourly earnings came in m/m at 0.2%, putting the three month average at just 2.4% annualized. The headline average hourly earnings of 3.9% was the lowest in three years. This is good news for the inflation story and drop kicking JMo into 2026.
July odds for a cut jumped to 35%, while September spiked to 67%.
Odds of no cuts by year end stand at just 8.5%.
Remember, the “jobs report” as we know it is really two different surveys.
Establishment Survey (aka Non-Farm Payrolls aka NFP)
- Added 175k jobs
- Birth death adjustment added 363k jobs
- You read the right – if this estimate had been just 187k instead of 363k, the headline would have reported job losses
- If Pensford estimates $7 billion in “birth/death adjustment” revenue this year, do I get to pretend it’s real?
- $6.9B of that would instantly be spent on Amazon by the Real Boss, so it wouldn’t really matter that much
- If Pensford estimates $7 billion in “birth/death adjustment” revenue this year, do I get to pretend it’s real?
- You read the right – if this estimate had been just 187k instead of 363k, the headline would have reported job losses
- Birth death adjustment added 363k jobs
- Last month’s gangbusters number was actually revised higher, but February’s was revised so much lower that the net effect across both months was still a downward revision of 22k
- The government contributed just 8k last month, compared to the average over the last year of 55k
- Healthcare made up 87k of the 175k
- I’m apparently the only person that cares that half of all job growth is tied to government spending…please keep calling the labor market “hot” without any regard for how much in government spending it takes to create those jobs…
Household Survey (aka Unemployment Rate aka UR)
- We added 25k jobs last month, just a tad lower than the 175k reported in the NFP
- Here’s what so weird…the job gains were in full time. We added 949k full time jobs and lost 914k part time jobs, the exact opposite of the recent trend. I don’t have the slightest clue what to make of that.
- The unemployment rate ticked up to 3.9% while the participation rate held steady
- I wonder what sort of psychological effect a 4-handle would have on the media? Or the Fed?
- The Fed is projecting the unemployment rate to finish the year at 4.0%, just 0.1% higher than Friday’s release…and that was tied to 3 cuts…what if the UR goes to 4.5% this year? How many cuts then?
SMBC put together analysis that combines people coming off the sideline (that previously weren’t being counted as unemployed since they weren’t looking) plus people actually losing their jobs. The trend is not good.
On top of all that, the SF Fed just came out with an update to the excess savings tracker. Whoops…
If excess money is gone for most, I think the health of the economy is entirely dependent on the labor market. The wheels haven’t fallen off because people still have jobs. They can pay the bills and those recent credit card balances they’ve racked up…for now…
But job losses are non-linear events and my pea brain is literally incapable of processing the possibility of a sudden surge in the unemployment rate. It doesn’t move up in a nice, linear, predictable fashion.
I continue to believe we are underestimating the potential jump in unemployment. And I absolutely believe it will finish the year higher than the Fed’s projection of 4.0%.
Bloomberg Rates still expects the 5yr and 10yr Treasury to finish the year below 4%. Tapering of QT. Softening of economic data. More and more time for positive real interest rates to do their thing…
The Week Ahead
Plenty of Fed speeches to massage the market reaction to Powell’s press conference and Friday’s job data.
Today we get the SLOOS report, which the Fed had in hand at the last meeting. I wonder if it showed enough tightness on the lending side to persuade Powell to not go full hawk.
Otherwise, a quiet data week. Next main event isn’t until CPI on May 15th
