Bracing for change

This was a big week for market forecasters. The data released this week was all about the payroll data and it would weight heavily on the FOMC decision coming up in two weeks.

The JOLTs numbers came out on Wednesday and showed a significant decrease in the amount of job openings.

Openings have been in a steady decline since the peak in March ‘22. In addition, the openings figures have been consistently revised lower. July’s number of 7.673 million openings showed a decline of 237k openings from the previous month of June, which was revised down to 7.91 million.

The all important openings/unemployed shows that the data has made a round-trip and returned to pre-covid levels.

Thursday saw the ADP employment data which showed 75,891 job cuts in August. This was the most in five months. Excluding the covid crash in 2020, this was the most since 2009.

For me, the more important release dealt with productivity and hourly earnings.

Productivity continues to show improvement above and beyond the pace prior to 2020. Unfortunately this productivity has not showed up as increased hourly compensation for workers.

This continues to put the pinch on consumers as they get grinded down with inflation and stagnate (or negative) real wage growth.

After all this troubling employment data, the BLS kept the best for last. Today they released the unemployment rate which dropped, to 4.2%.

This really played havoc with the traders betting on a 50 basis point cut from the Fed later this month. The odds of that have crumbled to 29%. Instead the market is predicting a 71% chance for a 25 basis point cut.

Count me in on the 25 basis point cut camp. I felt this really rings true with what both NY Fed President John Williams and Fed Govenor Waller, spoke to today.

Starting with Williams;

“I expect GDP growth this year to be around 2 to 2-1/2 percent. I expect the unemployment rate at the end of this year to be around 4-1/4 percent, and thereafter to move gradually down to my estimate of its longer-run level of 3-3/4 percent. With the labor market in balance, I expect the process of disinflation to continue. Specifically, I expect overall PCE inflation to moderate to around 2-1/4 percent this year and to be near 2 percent next year.”

“The risks to our two goals are now in better balance, and policy needs to adjust to reflect that balance. Of course, one clear lesson of the past several years is that the future is highly uncertain. Therefore, our decisions will be data-dependent, with a keen eye on the achievement of our maximum employment and price stability goals.”

President Williams continued to toe the line from the last FOMC meeting that the Fed sees their mandate to be in better balance, even naming his speech “‘E’ is for Equipoise”.

Gov Waller was much more transparent;

“Now let me discuss the implications of this outlook for monetary policy. As I said at the outset, considering the achieved and continuing progress on inflation and moderation in the labor market, I believe the time has come to lower the target range for the federal funds rate at our upcoming meeting. Reducing the policy rate now is consistent with many versions of the Taylor rule, which suggest reducing the policy rate is appropriate given the data in hand.

Furthermore, I do not expect this first cut to be the last. With inflation and employment near our longer-run goals and the labor market moderating, it is likely that a series of reductions will be appropriate. I believe there is sufficient room to cut the policy rate and still remain somewhat restrictive to ensure inflation continues on the path to our 2 percent target.

Determining the appropriate pace at which to reduce policy restrictiveness will be challenging. Choosing a slower pace of rate cuts gives time to gradually assess whether the neutral rate has in fact risen, but at the risk of moving too slowly and putting the labor market at risk. 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. This would cause an undesired loosening of monetary policy.

Determining the pace of rate cuts and ultimately the total reduction in the policy rate are decisions that lie in the future. As of today, I believe it is important to start the rate cutting process at our next meeting. If subsequent data show a significant deterioration in the labor market, the FOMC can act quickly and forcefully to adjust monetary policy. I am open-minded about the size and pace of cuts, which will be based on what the data tell us about the evolution of the economy, and not on any pre-conceived notion of how and when the Committee should act. If the data supports cuts at consecutive meetings, then I believe it will be appropriate to cut at consecutive meetings. If the data suggests the need for larger cuts, then I will support that as well. I was a big advocate of front-loading rate hikes when inflation accelerated in 2022, and I will be an advocate of front-loading rate cuts if that is appropriate. Those decisions will be determined by new data and how it adds to the totality of the data and shapes my understanding of economic conditions. While I expect that these cuts will be done carefully as the economy and employment continue to grow, in the context of stable inflation, I stand ready to act promptly to support the economy as needed.”

Bold is mine.

I think the biggest takeaway from Waller’s speech is that the Fed continues to tout the data dependency of the Fed. As a voter, he is prepared to cut at the September meeting and that the process to finding a final rate will take time.

My worry is that the market has gotten ahead of itself and that the Fed isn’t prepared to cut 8 times in 12 months. Torsten Slok feels the same way:

This isn’t to say that the economy isn’t showing signs of distress. The dollar stores (dollar tree and dollar general) reported earnings and both had scary things to say about their consumers. Now Big Lots is preparing to file for bankruptcy. In the meantime I keep hearing how sausage sales continue to surge. Maybe its just preparation for Oktoberfest?

All the while it appears that traders are increasingly betting on recession by dumping on small caps, oil, and commodities. I also feel there has been profit taking in the market as concerns over the unrealized capital gains tax proposal have taken hold. This idea has already been flip-flopped and walked-back but once the cat is out of the bag…