It's been a while since I had a public post on Credit Writedowns. So I thought now would be a good time to post given Wednesday's Fed rate decision and presser and today's jobs report. I think this one-two punch is a big deal. And that's because it forces the market back to a focus on the Fed's tightening bias from its focus on weak data forcing the Federal Reserve to cut. Thoughts below
Before I get to the data, let me spell out how to think about the market and the economy right now.
Nothing in the data now or in the recent past speaks to an economic recession. We're in the longest expansion in US history. And given we had both an enormous global financial crisis and a European sovereign debt crisis during this expansion, it makes sense that people point to signs of weakness in the data as potential precursors to recession.
But the reality is that the data don't point to a recession and they never have. All the things I look for are benign. For example, jobless claims have yet to rise year on year. The spread between 2 and 10-year bonds hasn't gone negative, not for a single day. The ISM and Markit PMIs for manufacturing haven't reached the low 40s. Sure, a lot of the numbers have been weak. But nothing has signaled or is currently signaling recession, just a growth slowdown.
The Fed gets this. And for them, the question, since they announced the tapering of large scale asset purchases (aka quantitative easing, or QE for short) over six years ago, has always been how do we normalize policy. If there's one thing you have to realize in all of this, it's that the Fed has been uncomfortable in a role that mandated mid-cycle monetary easing.
All along the way, the Federal Reserve has desperately looked for ways to dial back its accommodation without crashing the economy. And they've been successful so far - from the taper tantrum to the rate increase in December 2015 and pause in 2016 to the rate hike cycle in 2017 and 2018 to the reversal in 2019. In each instance, the Fed has tried to 'normalize' policy. And that just means they have wanted to end mid-cycle accommodation and reload their rate cut gun for more dire times. And in each case, the Fed has succeeded by not crashing the economy.
So, as we head into 2020, the question has always been this: how hawkish can the Fed be and still give the US economy breathing space to grow? What the Fed has been telling us is that they have been forced to cut because of data weakness, but that they want to stop cutting as soon as they possibly can. That's essentially what Fed Chair Jerome Powell told us Wednesday. And today's data tell us the Fed now has the green light to pause indefinitely.
Here's what we saw. I'll use New York Times reporter Neil Irwin's twitter feed to make the points here.
Pre-report (link): "Consensus forecast is for a GM-strike depressed +75k jobs, Unemployment rate edging back up to 3.6%, from 3.5%, average hourly earnings +0.3%."
Numbers (link): "+128k payrolls. Unemployment rate ticks up to 3.6%. +0.2% on wages, +3% y-o-y, positive revisions."
Auto strike (link): "Auto manufacturing employment dropped 42k due to GM strike. Quite strong payroll numbers when you that adjust for that temporary effect and consider huuuuge positive revisions."
Labor Force Participation: Up to 63.3% overall (link). "Nice pop on prime-age employment-to-population ratio to 80.3%, highest of this cycle and matching the high of the 2007 cycle. Still below 2000 peak." (link)
Conclusion (link): "This is definitely a "no more rate cuts" kind of jobs report."
The most important factor here is upward revisions. That's always a positive sign regarding unexpected acceleration. And the revisions were pretty huge. August’s initial +168,000 non-farm payrolls number was revised up to +219,000. And September’s number jumped from +136,000 to +180,000. Total revisions were +95,000
If you add in the 42,000 workers idled by the GM strike, that's137,000 additional workers on top of the 128,000 baseline number. That's big.
What does the Fed do with this information?
On Wednesday, the Federal Reserve cut interest rates for the third time. There were two hawkish dissents again as well. In the press conference after the FOMC decision, Powell told us they would not cut any further unless the economy slowed dramatically. So, this jobs report puts paid to that guidance. It tells you, there are likely no more cuts coming this year, and that the Fed is on hold indefinitely.
The market is resisting this. All of the market economists I heard yesterday were saying that a weak consumer in Q4 puts a December cut on the table. Their stress was on poor data forcing the Fed back into retreat. But, after today, the focus has to be on a Fed tightening bias in the face of a potential bottoming of economic data. This jobs report is a game-changer regarding monetary policy.
What's more is that the Dallas Fed's inflation measure exceeded the Fed's target in September. And so, there is the real possibility that inflation measures could bottom with economic data, causing a wholesale reversal in market thinking about Fed policy.
My own view here is that downside risks still remain next year. And in fact, a Fed pause increases those risks for 2020. I'm not concerned about the near-term. I am more concerned about mid-2020 in the face of a Fed with a tightening bias. We have a long way to go until we reach a tipping point.
For now, the message has to be that the recessionistas have been caught out. And the Fed is not willing to cut further. That's bullish for the US dollar, but not so bullish for Treasuries.