FOMC meeting. Job report. Fed speakers. None of that matters. The Eagles host the Niners in what is sure to be an epic matchup. I could barely focus enough to write this and you may pick up on subliminal messages. If you see me at NMHC, just know I was pre-gaming at the NFC Championship in Philly and have mercy on me…
Last Week This Morning
- 10 Year Treasury at 3.52%
- German bund at 2.23%
- 2 Year Treasury at 4.21%
- LIBOR at 4.57%
- SOFR at 4.30%
- Term SOFR at 4.56%
- Core PCE, the Fed’s preferred measure of inflation, came in as expected
- MoM came in at 0.3%
- 3% * 12 = 3.6% in an overly simplistic back of the envelope annualized number
- YoY came in at 4.4%
- MoM came in at 0.3%
- UMich inflation expectations came slightly better than expected
- 5-year came in at 2.9% vs expected 3.0%
- 1-year came in at 3.9% vs expected 4.0%
- Real GDP (Q4 first estimate) came in at 2.9%
- More Americans are at least 60 days delinquent on their car payment than at the peak of the financial crisis
The Fed is Going to Hike 25bps This Week
For the first time since 2019, real rates will turn positive. This has been one of the primary goals of the Fed tightening cycle. The Fed believes negative real rates = accommodation, and the hikes aren’t considered restrictive until we enter positive territory.
Let that sink in for a minute – the Fed doesn’t even think it has been applying the brakes yet. It has simply been letting off the gas pedal (or accelerator for you EV fans).
Yet all signs point to a rapidly cooling economy. Inflation continues to trend lower - my crude math implies 3.6% Core PCE on a go forward basis. All that tightening is working, and maybe faster than expected.
Enter this week’s Fed meeting. There are some rumblings of a 50bps hike, but that’s not happening. If that was on the table, the Fed would have expended more energy convincing the market of that possibility.
After this 25bps hike, Fed Funds will be 4.75%. With Core PCE at 4.4%, real rates will now be in positive territory. 4.75% - 4.40% = 0.30%.
Given earlier statements, I think Powell wants real rates to be at least a positive 1.00% - 1.50% for an extended period of time. That will be applying the brakes. That will drive inflation to 2%. That will avoid a 1970s repeat where the Fed caved too soon in the face of rising unemployment and tanking stocks.
Letting Fed Funds hang out around 5% all year, while inflation continues to fall, will allow real rates to drift higher naturally. If the Fed hikes 25bps at the March meeting, that will put FF at 5%. As Core PCE falls to 4%, real rates will hit that 1% positive threshold. And with the job market’s alleged resilience, Powell thinks he has cushion to keep rates higher for longer.
Each cycle is different, but the economy has always added jobs heading into the Fed pause. 250k jobs gained each month is not necessarily a sign of a uniquely resilient job market - it’s how jobs always behave at this point in a tightening cycle.
Since we know job losses usually don’t occur until after the Fed starts cutting rates, I don’t understand the fascination with this as a leading indicator? There are clearly different dynamics at play this time, but I am not fully buying the JOLTs graph. I know everyone loves to say, “There are 1.7 job openings for every unemployed American”, but are there? Is that measure accurate? These companies must be surviving somehow with all those vacancies. I can’t help but wonder if some % of these are zombie openings.
Focusing on a data point that is a terrible leading indicator increases the odds of overdoing it and putting us into a worse recession than we would otherwise experience. I think there’s a chance at some point later this year the Fed will say, “Hey, it’s working, inflation is trending lower. We are going to drop rates by 0.50%-1.00% and then pause again.”
Letting a little slack out could extend the expansion and would potentially mimic the only soft landing the Fed has ever achieved (1995). After the tightening cycle ended, the Fed pretty quickly backed out 0.75% and avoided the classic slash and burn cycle.
Yet for now, the Fed is sticking to the “higher for longer” mantra. And if we’ve learned anything, it’s that we can’t listen to Fed-speak for accurate guidance on policy changes. The Fed won’t be talking about cutting until the moment before it cuts.
Week Ahead
The FOMC rate decision on Wednesday is the obvious driver this week, but Friday brings the next job report, too.
Honestly, the only thing that matters is Sunday’s Eagles Niners game. I will be there, and then will fly to NMHC.
Speaking of flying…
