Year: 2023

Fed Begins Pivot Toward Lowering Rates Officials don’t rule out further hikes while penciling in three rate cuts in 2024

Slowing inflation prompted Federal Reserve Chair Jerome Powell to pivot away from raising interest rates and toward considering when to cut them, igniting a rally on Wall Street.

The Fed held its benchmark federal-funds rate steady at a 22-year high on Wednesday and offered every reason to think that its most recent increase this past July probably marked the end of the most aggressive cycle of hikes in four decades.

At a press conference, Powell focused instead on the risk of causing unnecessary harm to the economy by leaving rates too high as inflation falls. “We’re aware of the risk that we would hang on too long,” he said. “We’re very focused on not making that mistake.”

Officially, the Fed’s policy statement indicated policy makers left the door open to raising rates again. “It is far too early to declare victory, and there are certainly risks,” Powell said.

But Powell’s comments made the carefully crafted policy communiqué feel stale less than an hour after it was released by suggesting officials had turned their attention to rate cuts. “There’s a general expectation that this will be a topic for us, looking ahead. That’s really what happened in today’s meeting,” he said.

Powell’s remarks, along with new projections showing Fed officials anticipated three rate cuts next year, marked a notable U-turn. For more than a year, he had warned that they would raise rates as much as needed to lower inflation even if that triggered a recession.

The comment about rate cuts was surprising because just two weeks ago during an appearance at Spelman College in Atlanta, Powell said it was too soon to speculate about when lower rates might be appropriate. (…)

Powell indicated officials were turning their attention to rate cuts because inflation has declined much faster than they expected. In their latest projections, they expected core prices, which exclude volatile food and energy items, to rise 3.2% this quarter from a year ago, down from their September projection of 3.7%. They see core inflation of 2.4% at the end of next year, down from their September expectation of 2.6%. (…)

Powell said it was too soon to say whether the last stretch of inflation reduction would prove harder than the ground covered so far. “We kind of assume that it will get harder from here, but so far, it hasn’t,” he said. (…)

“You wouldn’t wait to get to 2% [inflation] to cut rates,” Powell said. “It would be too late. You’d want to be reducing” the amount of “restriction on the economy well before you get to 2%.” (…)

• The Fed Underwrites the Recovery The central bank’s focus is now on preventing a recession, not just beating inflation. The market’s rally will help.

The Federal Reserve has two mandates: inflation and unemployment. For two years, though, it behaved as if only the first mattered, raising interest rates so steeply that it knew it was courting recession.

This week, it pivoted. “You’re getting now back to the point where both mandates are important,” Fed Chair Jerome Powell told reporters Wednesday after the central bank’s meeting. “We’ll be very much keeping that in mind as we make policy going forward.”

This pivot means the Fed is ready to backstop the economic recovery. It doesn’t rule out a recession, but makes one much less likely.

Officially, the Fed is still unsatisfied with inflation, which Powell said remains too high. Officially, it says it’s more likely to raise rates than cut them at their next few meetings.

Unofficially, the Fed thinks inflation, which has fallen much faster than almost anyone expected, will be in the vicinity of its 2% target before long, and the priority in the coming year will be lowering rates enough to prevent a recession.

In their projections released Wednesday, officials see the federal-funds rate target ending 2024 between 4.5% and 4.75%, 0.75 percentage point lower than today, and a half-point lower than they projected in September.

More important than the numbers was the decision to publish them. Before the meeting, there was speculation that Powell and his colleagues would strike a hawkish tone to rein in markets that had already priced in rapid rate cuts. Instead, they ratified those expectations, and thus effectively eased monetary policy. (…)

The big news this week is that the Fed now cares about unemployment, not just inflation. Don’t expect it to stop caring about inflation for a very long time.

• Powell Pivots Toward a Happy New Year The Fed’s move catches markets by surprise. Time will tell if it’s too soon for the economy, but the biggest risk could be in the US elections.

(…) The market moves that followed show that I wasn’t the only one to be taken by surprise. And we’ll need to wait a few more years to see if Powell and his colleagues follow through, and whether they were right. In the main, I didn’t expect this because I thought it a bad idea; so I’m worried by this development. It also makes life trickier for other central banks meeting on monetary policy over the next few days — although it made life that much easier for Brazil’s, which cut its target Selic rate by 50 basis points a few hours later. (…)

The shift in bonds predictably weakened the dollar, which will be particularly popular in the emerging world. It should also make it that much easier for the European Central Bank to make its own volte-face toward lower rates and deal with an economy that appears in much worse shape than America’s. (…)

The Bank of Japan, out of sync with the rest of the world, is contemplating whether to hike rates and normalize policy, as discussed here earlier this week. A month ago, the yen was spectacularly weak, trading below 150 per dollar. Since then, it has strengthened sharply thanks to speculation about both the Fed and the BOJ. Powell has successfully brought the yen back to 142.5 per dollar. (…)

Team Transitory Makes a Comeback

Whether the Fed is right to make this change depends entirely on the future course of inflation and employment in the US. That is their mandate and how they should be judged. Data of the last three months generally showed inflation slowing but remaining too high for comfort, and the labor market loosening a little but remaining tight.

It’s difficult to see anything that should have changed the Fed’s governing narrative quite so much. As Points of Return pointed out yesterday, the goods inflation that followed the pandemic really does appear to have been transitory. It’s now virtually back to zero. Services inflation, covering a much larger chunk of the economy, remains roughly double pre-pandemic levels. That’s mostly driven by housing costs and service sector wages, which are in turn moved to a great extent by monetary policy.

Stopping the hiking campaign at this juncture seems to make sense. But after all the focus the Fed has directed to so-called “supercore” inflation (services excluding shelter), offering such expansive guidance that rates will soon come down seems very premature. Just as a reminder, supercore was higher in November than in October on both a month-on-month and year-on-year basis. Does this no longer matter?

All of this feeds into the ongoing debate over whether inflation always was transitory. On Wednesday, Powell emphasized areas that were clearly driven by the pandemic, led by the supply shocks that were caused by labor shortages and ruptured supply chains. He also spoke at length on the need for humility. Almost nobody saw the US economy remaining so strong this year. Those of us (and this includes me as well as Powell and his colleagues) who were wrong about a likely recession in 2023 need to re-examine the assumptions behind it. We’ve been wrong about growth; maybe we’re wrong about inflation.

Back in 2021, when inflation rose menacingly, the Fed used the word “transitory” repeatedly. Those who agreed thought inflation would come down without intervention by the central bank, and became known as Team Transitory. Once headline US inflation topped 9% in the summer of 2022, they largely admitted defeat. The number of Bloomberg terminal stories using the word is still at far lower levels than in 2021.

If Powell’s new approach is right, then Team Transitory were broadly right, and we can expect services inflation to decline. We can also expect rates to come down from their unnecessarily high levels to avert a broad slowdown. If that does happen, then Powell — in conjunction with the Biden administration — will have pulled off one of the most remarkable acts of economic escapology in history. I leave it to readers to to try to visualize such a scenario and decide if it’s plausible. The data of recent months is consistent with that outcome, but it’s also consistent with something worse.

The greatest risks concern politics. The US has an election next year, which promises to be ugly and divisive. If the Fed does start cutting in early 2024, any really negative consequences wouldn’t become clear until after the election. If Joe Biden’s approval ratings on the economy do begin to improve, and it’s hard to see how they wouldn’t if the Fed’s projections are right, we can assume that Donald Trump will call foul. The perceived independence of the Fed, an important and much-criticized institution, matters a lot. It’s going to be tested.

Can we reasonably expect services inflation (78% of core-CPI) to decline?

• CPI-Services & wages YoY:

• CPI-Services MoM:

• Wages MoM: (BTW, in the latest NFIB survey, 30% of owners plan to raise compensation in the next three months, up six points from October and the highest since December 2021.)

• CPI-Rent (54% of CPI-Services, MoM):

• CPI-Rent & wages (correlation since 1964: 99.8%):

• CPI-Services ex-rent MoM (red line = 2014-2019 average of 0.17%):

What actually happened in the last 2 weeks?

• Jay Powell Dec 1: “It would be premature to … speculate on when policy might ease.”
• Dec 13: Rate cuts are something that “begins to come into view” and “clearly is a topic of discussion.”

There were 2 major new data:

1. Stronger employment growth along with rising hours and accelerating wage gains propelled aggregate weekly payrolls up 0.75% after 0.0% in October. Averaging the last 2 months, the 4.6% annualized rate is only slightly weaker than the previous 3-month average of +5.0%. On a YoY basis, labor income is up 5.4% in November, up from 4.9% in October, suggesting steady, if not accelerating consumer spending given CPI and PCE inflation of 3.2% and 3.0% respectively in October.
2. Core CPI came in up 0.28% after 0.23% and 0.32% in the two previous months. 3-m average: +3.4% a.r. vs +2.5% during the previous 3 months. Inflation on services, both rent and “other core services” has stabilized at twice pre-pandemic trends. CPI-Rent keeps rising at 0.5% MoM (last 4 months). Core services ex-rent picked up to +0.44% in November after a hart-warming +0.22% last month. Last 3 months: +5.2% annualized.

This might help, but who knows?

Oil Demand Growth Shows Signs of Sharper Slowdown, IEA Says The IEA slashed estimates on weakening economic activity in key countries.

The IEA sliced nearly 400,000 barrels a day from assessments of consumption growth for the final three months of 2023, and continues to expect that growth rates will decelerate dramatically next year. Meanwhile, soaring production from the US, Brazil and Guyana is offsetting production cuts by Saudi Arabia and its OPEC+ allies, it said.

“Evidence of a slowdown in oil demand is mounting,” the Paris-based adviser said in its monthly report on Thursday. “The increasingly apparent loss of oil demand growth momentum reflects the deterioration in the macroeconomic climate.” (…)

Global oil demand growth remains on track to increase by a substantial 2.3 million barrels a day this year to average a record 101.7 million a day, bolstered by the remnants of the post-pandemic rebound in consumption.

Yet growth will slow by roughly 50% next year to 1.1 million barrels a day as that rebound peters out, and consumers turn to more efficient or electric vehicles. The rise in consumption can probably be satisfied by a similar increase in non-OPEC+ supplies, the agency said.

And that, thanks to warm weather:

Bank of England says interest rates to stay high for ‘extended period’ The Bank of England’s Monetary Policy Committee voted 6-3 to keep rates at a 15-year high of 5.25%

There was no discussion of cutting interest rates, and the BoE remains concerned that inflation in Britain will continue to be stickier than in the United States and the euro zone.

The central bank also largely shrugged off data showing a slowdown in wage growth and a 0.3 per cent fall in gross domestic product in October – which raises the prospect of a recession in the run-up to a national election expected for 2024. (…)

EARNINGS WATCH

The S&P 500 has diverged from its earnings revision breadth.

Source: Morgan Stanley Research; @dailychartbook

SENTIMENT WATCH

That was before yesterday:

A lot more indicators are showing excessive optimism than pessimism

Even though it seems like consumers and investors want reasons to be pessimistic, and (depending on the source) they’re saying they’re pessimistic – or at least not all that optimistic – some objective indicators show that they’re buying stocks, even if they’re holding their noses.

After several potential warnings went unheated and stocks continued to rise, more indicators registered optimistic extremes this week. Most models we follow, including Smart/Dumb Money Confidence and Fear & Greed, show excessive optimism. A simple look at the number of indicators registered an optimistic extreme versus pessimistic extreme from the Dashboard shows how unbalanced one side is.

The percentage of the core indicators showing optimism minus those showing pessimism widened well into extreme territory last week and has stayed there. A 10-day moving average of the spread has now cycled from negative (more pessimistic than optimistic indicators) to +40%, the 2nd-highest level in two years.

Returns in the S&P 500 after the spread cycles like this were mostly positive. The sweet spot was 1-3 months after it reached extreme optimism territory, with the S&P rising 70% of the time. There were two large losses out of the ten signals.

As we often see, context can be critical, especially how quickly these sentiment cycles occur. The table below filters the table to include only the quickest cycles when it took about three months or less to cycle from negative to extreme optimism.

While the sample size becomes uncomfortably tiny, the S&P’s behavior after these quick cycles was pretty consistent. It didn’t suffer any losses over the next two to three months, with returns that were all within a couple of percent of each other.

Contrast that with the cycles that took the longest. After these slow-rolling cycles, the S&P’s returns were more bifurcated, with three losses and a couple of gains over the medium-term.

(…) The fact that optimism has rapidly returned to excessive territory after modest pessimism in October suggests that while returns might be moderate going forward, there isn’t much evidence that the peak and crash that doomers are hoping for is likely.

US Consumer Prices Pick Up in Bumpy Path Down for Inflation Core and overall CPI accelerated in November from prior month

(…) Shelter prices, which make up about a third of the overall CPI index, rose 0.4%, offsetting a decline in gasoline prices. Economists see a sustained moderation in the shelter category as key to bringing core inflation down to the Fed’s target.

Excluding housing and energy, services prices climbed 0.4% from October, picking up from the prior month, according to Bloomberg calculations. (…)

Unlike services, a sustained decline in the price of goods has been providing some relief to consumers in recent months. So-called core goods prices, which exclude food and energy commodities, fell for a sixth month, matching the longest streak since 2003.

“This report paired some serious deflation in core goods with strength in core services,” Omair Sharif, founder of Inflation Insights LLC, said in a note. “As such, I don’t think this is a great number for Fed officials, or market participants, hoping to change the conversation to rate cuts.” (…)

So many ways to skin the inflation cat.

I think this chart from Goldman Sachs pretty well sums up what’s going on: the 6m annual rate of change of core CPI is almost back to its pre-pandemic level.

But only because core goods prices (21% of CPI) have been deflating as supply channels unclogged and China exports its own goods deflation.

One might even argue that all this Fed-tightening since spring 2022 has yet to actually impact demand.

Inflation on services, both rent and “other core services” has stabilized at twice pre-pandemic trends. CPI-Rent keeps rising at 0.5% MoM (last 4 months) despite everybody’s year-long forecast that rentflation would “soon” melt down.

Core services ex-rent picked up to +0.44% in November after a heart-warming +0.22% last month. Last 3 months: +5.2% annualized.

Bloomberg’s John Authers:

For years, services ran at about 2% per year, while goods inflation was zero. They spiked together in 2021 and 2022, but now goods is back to zero (so there’s certainly an argument that this element of inflation was transitory), while services is still at roughly double its pre-pandemic norm. Annual core services inflation was unchanged in November compared to the previous month. (…)

Today’s Authers’ column will surely feed the rent bulls:

If we look at indexes of rents based only on the leases taken out in the last month (rather than on all leases currently in effect regardless of when they started), then the one kept by real estate group Zillow has a mixed message. Rents have been falling for the last two months, it says, but that followed a string of gains, which are also yet to show up fully in the data:

But if you closely look at the chart, you notice the obvious seasonality of the data.

It so happens that Zillow also provides a seasonally-adjusted series which shows that rents have actually been rising continuously, including the 0.3% MoM advances in each of the past 2 months.

This is for new rentals where supply is rising, as opposed to renewals, 90%+ of all leases, which the BLS data measure.

The Fed would be mistaken to even hint at “mission accomplished”.

A few charts from the Atlanta Fed:

  

  

Country Garden Surprises Creditors With Full Yuan Bond Repayment

Country Garden Holdings Co.’s representatives told some holders of its 800 million yuan ($111 million) bond with a put option due Wednesday that it has remitted funds to fully repay the note’s principal outstanding and interest, people familiar with the matter said.

With the unexpected decision for full repayment, the distressed Chinese developer will avoid what would otherwise be its first default on a local yuan bond. (…)

But challenges facing the company, which is one of the world’s most indebted developers, have by no means ended. It posted a 77% in sales in November despite a slew of policy measures to revive homebuyers’ confidence. (…)

• Chinese Leaders Vow to Step Up Support for Flagging Economy Pledges on government spending and monetary support come as data points to slowing growth

(…) Still, Chinese leaders offered few specifics Tuesday on how they intend to reignite consumer and business confidence and reinvigorate growth.

Chinese leader Xi Jinping presided over the two-day meeting, where leaders urged officials to increase fiscal stimulus and help expand domestic demand, according to Chinese state media. They also acknowledged economic challenges, including “excess capacity in certain industries and weak sentiment in the society,” according to a readout of the meeting. (…)

At the meeting, Chinese leaders vowed to expand consumption and raise income for both urban and rural residents but offered little sign that they may pivot to giving cash handouts to households, despite repeated calls from policy advisers and economists to do so. (…)

Still, the meeting didn’t spell out a plan to help cash-strapped developers finish tens of millions of uncompleted apartments, a crucial step that economists believe will help restore household’s confidence in the government. (…)

• China Official Vows to Prevent Deluge of Defaults by Developers

A top Chinese housing official pledged to avoid a cascade of debt defaults by property developers, among the strongest commitments yet to cushion an escalating real estate liquidity crisis.

China will “forcefully prevent developers from defaulting on their debts all at once,” Dong Jianguo, Vice Minister of Housing and Urban-Rural Development, said at a conference on Wednesday, state broadcaster China Central Television reported.

Regulators will satisfy the reasonable financing needs of builders and help them to solve short-term cash problems, the vice minister said. (…)

The escalation in rhetoric is unusual because Chinese authorities have largely avoided directly commenting on developer defaults in official statements. (…)

The vice housing minister also differentiated between financially sound and insolvent developers on eligibility to receive government support. Builders that violate regulations and lose operating capabilities should be liquidated under the rule of law, Dong added.

SENTIMENT WATCH

The Rising Tide That Lifted Some Dead Cats (John Authers)

The rally that began in late October, spurred largely by the perception of a volte-face by the Federal Reserve, has lifted almost any asset you could name. (…)

The following dashboard graphs everything with 100 set for Oct. 27, the Friday when the S&P 500 hit bottom. The pattern is strikingly similar across assets, but it’s startling to see how those most out-of-favor have fared best. Commercial real estate, led by offices and retail malls, has rebounded almost 30% in six weeks, while US regional banks have gained more than 20%. Lower rates should directly help real estate, by making their rental yields more competitive, while any reduction in long-term yields should raise the price of the bonds burning a hole in regional banks’ balance sheets and offer them a chance to recover, so gains on news of falling rates make sense. The scale of the gains is impressive, however:

Perhaps most startlingly, if you really wanted to make money out of the market turn, you should have put it in meme stocks. The great hit of early 2021, meme stocks included companies with well-known brands that had fallen out of favor, such as GameStop and the AMC cinema group.

The meme stock phenomenon has fizzled so badly since then that the exchange-traded fund that traced the specially created Roundhill Meme index recently announced that it would be shutting its doors. And yet, somehow, that index has rebounded by a third since the market bottomed. The most heavily shorted stocks, as identified by Goldman Sachs, have also enjoyed a 20% rebound, although their prior fall had been even worse.

One area where the shift in rates sentiment seems to have made the greatest difference is in the emerging markets. The MSCI index for EM excluding China has enjoyed a rebound of more than 10%. With lower US rates and a weaker dollar, their prospects loom that much rosier.

It’s possible to label this as a broadening of a market that had grown alarmingly concentrated. It’s equally easy, however, to cast it as a “dead cat bounce,” the charming Wall Street term derived from the fact that even a dead cat will bounce if you drop it far enough.

The market can still continue to widen — which it will if “soft landing” data continues to come in — even as it weeds out some of the rebounds that owe more to liquidity-driven speculation than anything else.