Can Powell stick the landing?
Today’s price action in markets embodies the perfect ending to the inflationary cycle. The slowdown in job openings and consumer confidence is correctly being viewed as a signal that the Federal Reserve no longer needs to hike rates.
They’re not seen as a sign of an economy that’s lurching towards a recession and needs rate cuts.
It’s a perfect landing that balances growth and inflation. The soft data is coming with the Atlanta Fed GDPNow tracker running at 5.9% and the market sees that as plenty of rope before a recession is even a consideration.
That’s a tough logic to argue against but I also think that it will be tough for markets to continue to cheer as economic data deteriorates further from here. Soft data has been creeping in and that could soon be followed by outright job losses and a further retrenchment from consumers.
I’ve long argued that risk trades could run because now the Fed has 500 bps of rate-cutting power — that’s mountain of ammunition. However, it’s only good for the market once the Fed is ready to use it.
The mantra from all FOMC officials is that they need to be sure the job is done on inflation and that will mean keeping rates high longer than normally. But traders are weighing that against the long history of the Fed rushing to the rescue the moment things get rough.
Where that becomes a paradox is: Can it really get rough without a rout in the equity market?
Another way of looking at today’s positive price action is via the lens of the bond market. Bill Ackman and Bill Gross have been talking about higher Treasury yields, perhaps materially higher. That kind of blowout would imperil corporate balance sheets and the fiscal strength of the United States.
Whether yields blow out has been an ongoing debate but with the 10 bps drop in 10-year yields today along with a strong 7-year auction, the recent highs look like they could he a false breakout.
US 10-year yields daily
Perhaps today’s market response is simply a relief rally because those tail risks are being priced out. Yes, the economy is solid and Fed cuts aren’t coming but, no the rates market isn’t going to blow up and there won’t be another round of high inflation.
What next?
If you love economic data, this is a perfect market because what comes next will be determined by the numbers and we won’t have to wait long. Tomorrow we get ADP employment, initial jobless claims come Thursday and non-farm payrolls on Friday.
If data continues to disappoint, the market will eventually stop cheering on the end of rate hikes and start kicking and screaming for cuts. When does that happen? I don’t think the market will change its stance until the odds of a November rate hike are completely priced out. Right now, it’s still 50/50 so the ‘bad news is good news’ mode can continue for a few weeks.
In the meantime, the FX market is operating on a different set of rules and bad news is certainly bad for the US dollar (particularly USD/JPY) as it sinks to fresh session lows.