Big Rate Cut Forces Fed to Contend With New Obstacles Where is the Fed taking rates and how fast will it get there?

(…) Powell characterized the Fed’s latest cut, which lowered the benchmark federal-funds rate to between 4.75% and 5%, as “recalibrating policy down over time to a more neutral level.” While he has typically avoided offering specific pronouncements about where that might be, he volunteered on Wednesday that “the neutral rate is probably significantly higher than it was” before the pandemic.

“How high is it? I just don’t think we know,” Powell said. (…)

“There’s no sense that the committee feels it’s in a rush to do this,” he said. “I do not think that anyone should look at this and say, ‘Oh, this is the new pace.’” (…)

Officials will have two more months of labor-market data before the Nov. 6-7 meeting, including one report less than a week before their meeting. (…)

Fed officials are trying to balance two risks: One is that they drag their heels on reducing rates in a way that gives rise to rising joblessness and makes officials rush into bigger cuts. (…)

The other risk is that they move too fast in dialing back rate hikes. The chances that inflation gets stuck at a level above the Fed’s 2% target “increase if the Fed does continue to do 50-basis-point cuts going forward” when the economy doesn’t need them, said Maki. (…)

“There is thinking that the time to support the labor market is when it’s strong, and not when you begin to see the layoffs.” (…)

What Powell said:

• Recent indicators suggest that economic activity has continued to expand at a solid pace.
• The labor market is not a source of elevated inflationary pressures.
• The balance of risks are now even.
• All 19 of the participants wrote down multiple cuts this year. All 19.
• 17 of the 19 wrote down three or more cuts and 10 of the 19 wrote down four more cuts.
• You can see our 50-basis-point move as a commitment to make sure that we don’t fall behind.
• We made a good, strong start to this. And that’s really, frankly, a sign of our confidence – confidence that inflation is coming down toward 2 percent on a sustainable basis. That gives us the ability. We can, you know, make a good, strong start. And I’m very pleased that we did. To me, the logic of this, both from an economic standpoint and also from a risk management standpoint, was clear.
• The labor market is actually in solid condition. And our intention with our policy move today is to keep it there. You can say that about the whole economy. The U.S. economy is in good shape. It’s growing at a solid pace. Inflation is coming down. The labor market is in a strong place. We want to keep it there.
• Clearly, labor market conditions have cooled off by any measure, as I talked about in Jackson Hole. And—but they’re still at a level—the level of those conditions is actually pretty close to what I would call maximum employment, you know. So you’re close to mandate, maybe at mandate on that.
• We’re not seeing rising claims. We’re not seeing rising layoffs. We’re not seeing that. And we’re not hearing that from companies, that that’s something that’s getting ready to happen. So we’re not waiting for that.
• Anything in the low 4s [unemployment rate] is a really—is a good labor market.
• Certainly it appears that we’re very close to that point, if not at it, so that further declines in job openings will translate more directly into unemployment.
• We will continue to look at that broad array of labor market data, including the payroll numbers. We’re not discarding those. I mean, we’ll certainly look at those, but we will mentally tend to adjust them based on the QCEW adjustment which you referred to.
• Wage increases are still just a bit above where they would be over the very longer term to be consistent with 2 percent inflation, but they’re very much coming down to what that sustainable level is. So we feel good about that.
• It feels, to me, that the neutral rate is probably significantly higher than it was back then. How high is it? I don’t — I just don’t think we know.
• I don’t see anything in the economy right now that suggests that the likelihood of a recession—sorry—of a downturn is elevated, OK? I don’t see that. You see—you see growth at a solid rate. You see inflation coming down. And you see a labor market that’s still at very solid levels. So I don’t really see that, no. 
• For a time you can have the balance sheet shrinking, but also be cutting rates.

In all, a strong economy, a strong labor market with nothing that suggests a downturn, and inflation confidently coming down to target. Nirvana!

But the current policy is judged as too restrictive (!) and they don’t want to fall behind, so they are now managing risk, which they consider balanced, but still needs a strong 50 point cut.

So long the data-dependent Fed, hello again preemptive policies, really focused on the labor market, with key data so unreliable that they will “mentally tend to adjust them”.

No mental adjustment is necessary on Indeed Job Postings which clearly show that job openings have stopped declining (through Sept. 13), still 12% above pre-pandemic levels.

John Authers:

The first cut to the benchmark fed funds rate in four years was a big one of 50 basis points. Market pricing had moved in the last few days to imply that there was a slightly better than 50-50 chance that this would happen, but the economists away from the trading floor largely weren’t expecting it. Only nine out of 113 economists who responded to Bloomberg’s survey expected a cut of this magnitude.

The Federal Open Market Committee accompanied the jumbo move with a big shift in its predictions for where the rate will be at the end of this year and next, set out in the quarterly Summary of Economic Projections, commonly known as the dot plot. The median expectation for the end of both 2024 and 2025 dropped by 75 basis points. This isn’t extraordinary, as they made exactly the same adjustment earlier this year. It would bring the effective rate to 3.4% by the end of 2025, compared to the 5.33% where it’s been set for the last 14 months. But such a drop is unusual at a time when there’s no obvious crisis to change the perceived balance of risks. (…)

The median dot suggests that there are only 50 basis points more in cuts to come this year. No more jumbos. (…)

Asked whether it had been a mistake not to have cut at the last meeting in July, he admitted that the Fed probably would have moved if it had had access to the surprisingly good inflation numbers for June, which were published shortly afterward. In other words, Wednesday’s cut should be seen as a “catch-up” and not a harbinger.

That helped him tackle the greatest objection to such a steep cut, which is that it simply wasn’t necessary. Big cuts generally happen at times of great stress — most recently the pandemic and the Global Financial Crisis. According to the Chicago Fed’s index of financial conditions, things presently are about as lenient as they get. The last time the Fed cut this much when financial conditions were set this fair was way back in 1992: (…)

The key for Powell, to use the phrase of Goldman Sachs’ Lindsay Rosner, was to convince his listeners that this was “a focused 50, and not a fearful 50.” (…)

Powell managed to convince all and sundry that he was cutting from strength, not weakness, and narrowed the gap between him and the markets. (…)

CONSUMER WATCH

Pretty Good Shape Credit card issuers seem to agree that the consumer is in decent shape

• “We believe that consumer spending remains healthy… if you compare the trends and what we saw in July and the trends, what we see in August, they are very consistent.” – Mastercard ($MA ) CEO Michael Miebach
• “Quarter-to-date, things are looking generally stable with Q3, and that’s in the U.S. and a number of major markets around the world. U.S. payment volumes quarter-to-date through August are up 5%, which is consistent with Q3.” – Visa ($V ) CFO Chris Suh
• “We released Q2 earnings a few weeks ago, and the word that I used back then was stable. Stable in a slow-growth economy. Over the last six, seven weeks, nothing has really changed much.” – American Express ($AXP ) CFO Christophe Le Caillec
• “The consumer is actually in pretty good shape. We can see their balances in their account. We can see on the loan side, delinquencies. And there’s been no abrupt changes there. Losses like for credit cards have been in the 4% range for us or lower. That’s about normal. So again, we don’t see anything from the consumer that causes us to believe there are problems there.” – Regions Financial ($RF ) CFO David Jackson Turner
• “When we look at the spend and we pulled this data, we don’t see signs of stress in the consumer… When we look at spend on our cards for Walmart, Target, Costco, BJ’s, we do not see any shifts in behavior.” – Synchrony Financial ($SYF ) CFO Brian J. Wenzel
• “I think the consumer is in a reasonably strong shape, and it’s been true for quite a while.” – Capital One Financial ($COF ) CFO Andrew M. Young
• “I think most people are still doing pretty well, whether it’s on the consumer side or the commercial side.” – Wells Fargo ($WFC ) CFO Mike Santomassimo
• “From our vantage point, the US consumer is doing fine. I wouldn’t qualify it as rolling in its spending government check, like nothing of that sort. I think it’s fine. I don’t think it’s amazing. But I don’t think it’s weak. I don’t think it’s falling off a cliff.” – Affirm ($AFRM ) CEO Max Levchin
• “Folks on the lower side of the income or wealth spectrum are struggling more… you’re starting to see higher delinquencies in that market. Not a huge piece of our business, but nonetheless, you’re seeing some stress there.” – Wells Fargo ($WFC ) CFO Mike Santomassimo
• “Higher interest rates and the effect of inflation are pressuring customers’ ability to spend. This is especially true for our most budget-conscious customers, as we’ve been seeing for a while now, but we’re now seeing other customer segments beginning to make changes as well… Customers are purchasing lower-priced cuts of meat, buying less and focusing on essentials.” – The Kroger Co. ($KR ) CEO Rodney McMullen
• “I think when you move up the income ladder, we continue to see people pulling back on discretionary purchases, not in a troubled way, but just a pullback.” – Synchrony Financial ($SYF ) CFO Brian J. Wenzel
• “What we see is that the US economy, even though we see some slowdown, is still doing okay, and the consumer is the main driver of that growth. So what we see is consumption is still there, and we have seen some change in behavior like discretionary consumption now stabilized, but it came down a bit, and non-discretionary is still growing at a slower pace but is growing.” – JPMorgan Chase ($JPM ) COO Daniel Pinto

On growth and inflation:

• “And so, we believe and we’re seeing in our portfolio, companies, inflation in the rearview mirror. The significant increase in input costs is down close to zero. Wages are continuing to grow, but at 3 or 4 percent, not the 6 – 7 percent. We’re seeing rents come down across most of the real estate asset classes. And we don’t see the inflation in our companies that the Fed is currently talking about. And we are seeing the US economy slowing and the European economy very slow.” – Blackstone ($BX ) Global Head of Private Equity Joe Baratta
• if you are going to cut 75 basis points between now and year-end, you’re much better off cutting 50 basis points now because you’ll spur more economic activity next year because corporations are making decisions about next year now. And if they know they have 50 basis points on a huge balance sheet of debt, they could do more hiring, they could do more investing even having that information.” – SoFi Technologies ($SOFI ) CEO Anthony Noto
• We then have been asking, what would it take? What does the Fed need to do in order for you to be willing to invest. And the answer is I need to believe that the economy is going to hold up. And then generally, it’s about 100 basis points in cuts is what we have been hearing, like 4.5% would reach a point where more projects pencil out, where there would be more confidence in making some of those investments.” – Fifth Third Bancorp ($FITB ) President Timothy N. Spence

US Housing Starts Increase to Fastest Pace Since April New construction rose 9.6% in August to 1.36 million pace

(…) The report showed overall building permits, a gauge of future construction, rose 5% to a 1.48 million annualized rate, while single-family authorizations increased to a four-month high.

New construction of single-family homes increased nearly 16% to an annualized 992,000 pace, the first monthly advance since February. Starts of multifamily projects declined for the first time since May.

Builders are awaiting a sustained pickup in demand to help work down an inventory of unsold homes that’s hovering near the highest level since 2008. (…)

Starts jumped 15.5% in the South, a month after Hurricane Beryl led to the slowest pace of construction in the region since mid-2020. Homebuilding in August also rose in the Midwest and West.

Completions of new single-family homes declined 5.6% to the slowest pace since March. Multifamily completions jumped. (…)

Broad-Based Retail Weakness Despite Scant Gain

Some reports tell you everything in the headline, today’s retail sales report for August is not one of them. Yes the headline increase of 0.1% was better than the modest drop that had been expected. You can thank a smaller-than-expected drop in motor vehicle sales for that. The ex-autos line tells us more about the present state of the consumer after setting aside that big-ticket category, and here we find that sales inched only incrementally (+0.1%) higher in August.

U.S. Department of Commerce, U.S. Department of Labor and Wells Fargo Economics

There is fodder for multiple narratives in today’s retail sales report. Think consumers are finally tapped out? There is no shortage of categories in decline in August. General merchandise stores were down 0.3%, led lower by a 1.1% drop in sales at department stores. That is not what these retailers were hoping for in a key back-to-school month. Speaking of which, clothing stores were also down 0.7%. Furniture stores gave back most of the pick-up seen in July, and electronics and appliance stores saw sales fall 1.1% in August. Even food & beverage stores posted decline in August.

With that kind of broad-based weakness, the case for the unstoppable consumer is surely weakened, so how do you get a headline gain? One word answer: Ecommerce. The non-store retailer category that includes online spending is second only to autos in terms of dollars spent, and it rose a stout 1.4% in August. With some help from increased spending at drugstores and other smaller categories that explains the scant headline gain.

Source: U.S. Department of Commerce and Wells Fargo Economics

There are competing narratives about the state of the consumer at this stage of the cycle in which the Fed is poised to finally deliver on long-expected rate cuts. The question isn’t will the Fed cut rates at the conclusion of tomorrow’s monetary policy meeting, but by how much. Market participants have been parsing through each data release in recent weeks seeking the one that settles the debate. Retail sales did little to crystalize the degree of easing.

The deterioration in the labor market argues for Fed easing, yet many measures of growth demonstrate the economy is continuing to expand, including retail. But that divergence perfectly describes why this easing cycle is different and so hard to predict. Historically when the Fed starts to cut rates the economy is already in serious trouble. There are only few historic-references in which a Fed achieves the type of “soft landing” many anticipate today. The consumer may technically be unstoppable, but in recent months spending has undeniably slowed sharply. For policymakers already aware of the need to make the policy environment less restrictive, this weakening may encourage the Fed to deliver a larger cut to initiate its easing cycle.

Source: U.S. Department of Commerce and Wells Fargo Economics

Seven categories of retailers reported declines in sales last month and a pullback in some discretionary-like categories demonstrates choosier consumer behavior. Nothing in this report says everything is fine, spending has slowed. But at the same time the data don’t scream dramatic pullback in spending consistent with recession.

The retail sales data position for some upside risk to Q3 consumer spending. Control group sales, which exclude autos, gasoline, building materials and restaurants rose 0.3% in August amid upward revisions to prior months. These data feed directly into real personal consumption expenditures in GDP and position for slightly stronger goods spending that we had anticipated previously.

Some analysis tell you everything in the headline, Wells Fargo’s analysis for August is not one of them.

• Counting the number of categories in decline is rather superficial. Nonstore, miscellaneous and health care retailers, 24% of all sales and 30% of non-food-non-gas, grew their sales 1.3% MoM in August, that’s 16% a.r.!
• Control sales (ex-autos, gasoline, and building materials), which directly feed into GDP, rose 0.3% after +0.4% in July. That’s 4.3% a.r..

  

• My retail inflation proxy was flat again MoM in August. YoY it was –0.9% in August after +0.2% in June and July and +2.2% in September 2023. Retail inflation has thus declined 3 full percentage points in one year while nominal sales growth slowed only 2 pp. Real sales growth accelerated from +1.4% to +3.0% in the past year.

• Indeed, real expenditures on durable goods were up 3.4% YoY in July and real nondurables were up 1.7%. The combination was up 2.4% in July vs 2.56% one year ago. The chart below shows how close my real retail sales data is with real spending on goods. The black line is real services. All spending categories are in the 3.0% range in August.

BTW, the Atlanta Fed GDPNow estimate for Q3 rose from 2.5% to 3.0%. “The nowcast of third-quarter real personal consumption expenditures growth increased from 3.5 percent to 3.7 percent.” Goldman Sachs’ tracking is now at 2.8%.

Inflation in Canada Hits 2% Target for First Time Since 2021 Core measures decreased to average of 2.35% year-on-year

The consumer price index rose 2% in August from a year ago, following a 2.5% increase a month earlier, Statistics Canada reported Tuesday in Ottawa. That’s slower than the median estimate of 2.1% in a Bloomberg survey of economists. (…)

Excluding food and energy, the index rose 2.4% from a year ago. Services inflation rose 4.3%, while goods fell 0.7%. (…)

The inflation print is the first of two reports before the Bank of Canada’s next rate decision on Oct. 23. After the release of the data, traders in overnight swaps upped their bets for a larger-than-normal reduction at that decision, putting the odds of a 50-basis point cut at just over a coin flip. (…)

On a monthly basis, the index fell 0.2%, versus expectations for a flat reading, and rose 0.1% on a seasonally adjusted basis. (…)

Prices declined in five of eight subsectors on a monthly basis, which could trigger worries about deflation among central bank officials if it becomes a trend. Macklem has recently said the bank cares as much about undershooting the 2% inflation target as it does overshooting it. (…)

Earlier this month, Macklem reiterated that officials may cut rates by 50 basis points or more if inflation and the economy slowed faster than expected. (…)

Markets expect rates in Canada to fall to about 2.5% by July of next year — more than 50 basis points lower than they were pricing a month ago. (…)

The first Fed rate cut

(…) The last three cuts after a hiking cycle all preceded devastating bear markets. Before that, there was no real pattern. There was no discernable difference in returns based on how far the S&P 500 was from a multi-year high at the time of the first cut.

The table of maximum risk and reward across time frames shows a pretty binary result. Over the next year, stocks either enjoyed decent gains with low risk or limited gains with high risk. There wasn’t any middle ground. A decent heuristic was watching the next two weeks – if risk exceeded reward, then it was a strong suggestion that the following year would be tough. (…)

Opinions aside, the imminent cut in the Fed Funds rate has been a crap shoot for investors. There was no consistent pattern in forward returns after significant hiking cycles. The last few have been major warning signs, while most of the others were not at all. They were more consistently negative for the dollar (for a while), tech stocks (ironically enough), while being good for Treasury notes and bonds, value stocks, and defensive sectors.