Investors Are Almost Always Wrong About the Fed Wall Street is clinging to hopes for interest-rate cuts despite inflation fears.
Investors are more convinced than ever that interest rates are coming down later this year. Their record on these things, however, isn’t great.
Wall Street has been caught offside in both directions while betting on the path of interest rates over the past few years. Few thought the Federal Reserve would get anywhere near 5% in the first place. Now traders keep ramping up bets that rate cuts are just months away, only to see that day recede with each batch of strong economic data. (…)
Investors use futures markets to bet on the direction of central-bank policy. Right now, those show traders betting that the Fed will cut rates by more than a percentage point this year, much more than Fed officials are projecting.
Investors’ expectations for rates tend to be anchored to their recent memory. For nearly a decade after the 2008-09 financial crisis, for example, investors repeatedly (and wrongly) bet that rates would soon return to precrisis levels, according to an analysis by Bespoke Investment Group.
More recently, Wall Street didn’t expect the Fed to take rates to near 5.5%, or that it would hold them there for so long. When the Fed said in December that it expected to lower interest rates three times this year, investors bet on six cuts. After Chair Jerome Powell nixed the idea of lowering rates in March, they shifted their wagers to May.
The economy keeps beating expectations, preventing those bets from paying out. Last week’s blockbuster jobs report further enhanced the outlook. The Atlanta Fed now models inflation-adjusted growth as likely being 3.4% in the first quarter—well above levels that would suggest a need for rate cuts.
Wage growth, tracked by the Atlanta Fed, is at 5% as of January. The pace that prime-age workers are increasing their wages has yet to break below 5.4% since 2021. That worries investors and policymakers, because rising worker pay can feed inflation, keeping rates higher.
The healthy labor market also fuels consumer spending, in turn powering the economy. A retail-sales index from Johnson Redbook increased 6.1% last week from the same period a year earlier. (…)
As inflation falls, inflation-adjusted—or real—rates rise. Real rates are often considered a proxy for financial conditions in the economy because inflation factors into the cost of borrowing for households and businesses. Worried that real rates would rise so high that they discourage business activity to the point of sparking a recession, Fed officials have signaled that they could cut benchmark interest rates to avoid a substantial slowdown.
But one Fed official recently pushed back on the notion of cutting for the sake of real rates. Minneapolis Fed President Neel Kashkari argued that long-term real rates—measured via yields on 10-year Treasury inflation-protected securities—have only increased by a net 0.6 percentage point or so over the past year.
Because companies and individuals tend to borrow long-term to finance home purchases or new projects, that implies less drag on the overall economy than the real fed-funds rate suggests. (…)
A significant worry is what happens if inflation stays hot. Wall Street is now convinced that long-term yields are headed lower, but the latest reading of the consumer-price index came in at 3.4% and not everyone is certain it will continue to cool. That would keep rates high and potentially spark a destabilizing selloff in the bond market that could spread to stocks.
Bonds were already under pressure late last year because deficit spending prompted a surge in Treasury issuance that some investors worried would overwhelm demand. The U.S. presidential election is likely to signal more spending ahead, Papic said, bringing fears of rebounding inflation and higher bond yields back to the fore.
“The biggest risk to the stock market right now is the bond market,” Papic said.
Monitoring Changes in Inflation with Leading Economic Indicator Purchasing Managers’ Index ™(PMI)
In this research, we assess the track record of PMI as a leading indicator for inflation, relying on the leading indicator properties of PMI price indices – the Input Prices Index and Output Prices Index. These PMI series can provide signals for Inflation 3-6 months in advance of official CPI statistics and are used by investors and corporations for early signals into inflation and interest rate dynamics.
S&P Global’s price data suggest that inflation is flattening around 3% (PMI data are plotted with a 4-month lead).
The ISM’s measure of price pressures uses “prices paid” by corporate respondents, indicating trends in input costs eventually passed through to clients. A more upstream indicator of potential downstream pressures.
“ISM Prices Paid often leads the headline #CPI yet economists have paid no attention to the fact Prices Paid troughed in December…2022!!” (@RBAdvisors)
On wages, the Atlanta Fed Wage Tracker’s 3-m moving average is at 5.0%, down from 5.2% in December.
On a monthly basis, it fell from 5.4% to 4.7%.
These are unweighted.
Overall weighted wage growth rates have been steady at 5.2% since August 2023. The weighted series is constructed after weighting the sample to be representative of each month’s population of wage and salary earners in terms of sex, age, education, industry, and occupation groups.)
Job switchers: +5.6%, down from 5.7% in December but really flat since August.
Job stayers: +4.7%, down from 4.9%, roughly unchanged since October.
The next CPI report is next Tuesday. Many will be looking for the so far elusive rent relief in official data. Zillow’s data show “new rents” up 0.32% in December, down from 0.36% in November but in line with October.
Zillow’s data says that CPI-Rent remains 10.2% below “market”.
Manhattan Apartment Leases Surge, Keeping Rents From Sliding Leasing jumped and rents rose from a year earlier for the first time since October.
The median price on new leases was $4,150, up 1.3% from January 2023 and $100 more than this past December, appraiser Miller Samuel Inc. and brokerage Douglas Elliman Real Estate reported Thursday. A total of 3,922 rental agreements were signed last month, up 14% from a year earlier and the third straight annual increase.
New Yorkers have been seizing on apartment costs that have come down from the summer’s records. The intense demand — somewhat unusual for the dead of winter — has helped push up rents at a time when they might be expected to level off. While Manhattan’s median remains below the all-time high of $4,440 reached in July, it’s still well above pre-pandemic levels. (…)
Outer boroughs are seeing robust demand as well. New leases almost doubled from a year earlier in Brooklyn, where the median rent was little changed at $3,500. In northwest Queens — the neighborhoods closest to Manhattan — lease signings jumped 31% from the previous January, while the median rent slipped 5% to $3,200. Listing inventory declined in both boroughs.
In China, Deflation Tightens Its Grip Consumer prices fall at steepest pace in more than 14 years, intensifying fears that deflation could become entrenched
China’s deflation problem is getting worse, a stark symptom of a deepening economic malaise that spells trouble for the global economy.
Consumer prices fell for the fourth straight month in January, tumbling 0.8% year-over-year—the steepest decline since 2009, according to the country’s National Bureau of Statistics. Producer prices, which fell every single month last year, declined again in January as companies further slashed prices to find buyers. (…)
Signs of deflationary pressure in China are multiplying. Prices for fruit, vegetables and meat all tumbled in January. Prices for pork—a staple of the Chinese diet—were down 17.3% year-over-year.
Core consumer-price inflation, which excludes volatile prices for food and energy, slowed to a 0.4% annual rate from 0.6% previously.
Producer prices fell 2.5%, extending a run of declines into its 16th straight month.
It isn’t just goods. Services prices are also weakening, rising 0.5% on the year, half the rate notched a month earlier. (…)
Deflation can be a difficult economic problem to overcome. Falling prices eat into corporate profits and prompt consumers to delay spending in anticipation of bigger bargains tomorrow. That leads companies to cut prices and put off hiring and investment, further depressing spending and worsening the deflationary cycle. (…)
Income growth has slowed, making it harder for consumers to service their debts while maintaining spending. Workers are settling for lower-paid jobs in a tight labor market, and some data suggest salaries for new hires are falling.
Corporate profits are sliding, so companies with millions of yuan in debt are wary of investment and hiring. (…)
China has experienced periods of falling consumer prices before, notably in 1998 when a financial crisis ripped through Asia and in 2009 in the aftermath of the subprime mortgage bust in the U.S. that triggered bank bailouts worldwide.
In both those instances, China’s policymakers responded forcefully, flooding the economy with easy money by cutting interest rates and dishing out cheap loans. Growth and inflation soon returned.
But in juicing growth, they created a housing bubble that leader Xi Jinping is now determined to deflate. The result is a policy response that has been far more muted than in the past, with modest cuts to borrowing costs, smaller injections of cash into the financial system, and a jumble of piecemeal housing policies such as loosening restrictions on second home purchases in some big cities. (…)
Bloomberg:
Core CPI, which strips out volatile food and energy costs, rose 0.4%, slower than December and the weakest rise since June last year. Pork prices dropped 17%, helping drag down food prices by 5.9%, which was the biggest decline on record in data back to 1994.
ING:
The biggest drag in non-food inflation remains in transportation & communication (-2.4% YoY), where a decline in vehicle and communication device prices continued to suppress inflation.
In our view, the deflation argument is overstated, and the base effects makes January’s data look worse than they are. Sequential data paints a more upbeat picture. In MoM terms, headline CPI rose 0.3%, food CPI rose 0.4%, and non-food CPI rose 0.2%. While a far cry from the above-target inflation levels seen in many other economies, these numbers do not imply China is stuck in a deflationary spiral.
Furthermore, China’s pork cycle also indicates that the drag from pork prices will also fade in the coming months. While still a major drag in January’s data, pork price inflation has actually risen for the past two months, and the December 2023 MoM change in the pig stock was the largest decline since March 2022. With expected demand for the Lunar New Year holiday in February, this could return to positive growth in next month’s release.
As such, considering the more favourable base effects for February’s data, we see a high likelihood that January’s data could mark the low point for YoY inflation in the current cycle.
NBS commented that the deeper CPI deflation was mainly driven by floating holiday effects – Lunar New Year was in January for 2023, but in February for 2024.
China’s passenger vehicle sales fall 14.1% in Jan m/m Battery electric vehicle sales sagged 37% in January m/m
For the first time in 20 years, “made in Mexico” is outpacing “made in China.”
Mexico is now the top producer of goods shipped to the U.S., according to U.S. Census Bureau data released yesterday.
Together, American consumers buy from three major foreign sources: Mexico, China and Canada.
The U.S. absorbs more than $3 trillion worth of international goods a year. Those three countries account for more than a third of that total.
Data: U.S. Census Bureau, Bureau of Economic Analysis. Chart: Axios Visuals
Are Chinese stocks a value trade or a value trap? When an asset is declared ‘uninvestable’ it is often time to buy
Since 2015, always lower highs, but same lows … since 2009.
US Treasury’s Biggest-Ever 10-Year Auction Garners Solid Demand Auction for $42 billion awarded at 4.093%, below pre-sale rate
The notes were awarded at 4.093%, compared with a yield of about 4.105% moments before 1 p.m. New York time, the bidding deadline. The lower yield indicates stronger demand than traders anticipated. The auction result also broke a streak of tails — or a weaker result for the previous four monthly sales. (…)
Tuesday’s $54 billion auction of three-year notes also drew a lower yield than the one that had been predicted by trading at the bidding deadline, a positive sign. The US Treasury will complete its quarterly debt refunding Thursday with the sale of $25 billion of 30-year bonds. (…)
CBO Warns 2025 Debt Interest Costs to Exceed World War II Levels
(…) Net interest payments will climb to 3.1% of gross domestic product next year, the highest level in records going back to 1940, and then go on to hit 3.9% in 2034, the CBO said in its latest outlook for the federal budget.
“Net interest costs are a major contributor to the deficit, and their growth is equal to about three-quarters of the increase in the deficit from 2024 to 2034,” CBO Director Phillip Swagel said in a statement. (…)
Federal Reserve Chair Jerome Powell said last week that “it’s probably time, or past time” for politicians to work on getting the government “back on a sustainable fiscal path.” (…)
US debt held by the public is expected to reach $45.7 trillion, or 114% of GDP by 2033, according to the CBO’s latest forecasts. That’s actually down from the 118% projection for 2033 released a year ago.
But the nonpartisan arm of the US legislature also forecasts the average rate of interest the government pays on its debt will rise to 3.4% over the next 10 years, from the 3% predicted last year. (…)
“By next year, we’ll spend more on interest than on defense and nearly all other national priorities.” (…)
Medicare spending is expected to grow to 4.2% of GDP in 2034 from 3.1% in 2023, and Social Security outlays increase to 5.9%, from 5% last year. (…)
Wednesday’s CBO forecasts show the budget deficit reaching $1.58 trillion this year — down from $1.68 trillion 2023 — but swelling over time to $2.56 trillion by 2034. (…)
One particular assumption looks already under severe strain: that individual tax cuts included in former President Donald Trump’s 2017 Tax Cuts and Jobs Act will expire, as scheduled, at the end of 2025. That assumption boosts revenues from 2026 in the CBO’s projections.
But some Republicans, including Trump, have already vowed to make the cuts permanent. Biden has said he would extend the cuts for those earning less than $400,000 a year, but would match that with new revenue.
