Which one of these doesn’t belong? Inflation above target. Solid labor market. Booming stock market. Federal Reserve interest-rate cuts.
The consensus says all four are parts of the best-of-all-possible-worlds bull market, although a few economists and investment professionals are demurring on the last. While the markets have fallen in line with the Federal Open Market Committee’s current median projection of three reductions of one-quarter percentage point by the end of the year, those first three factors arguably point to fewer rate cuts, and perhaps even none.
The Fed’s preferred inflation measure, the personal-consumption expenditures price index, which was released as U.S. financial markets were closed for Good Friday, showed a 0.3% rise in core prices (excluding food and energy) in February, as expected.
As the chart above shows, that lowered the year-over-year rise to 2.8%, a marked deceleration from its postpandemic peak surge, and down from the mid-3% range just six months earlier. And it brought core PCE close to the FOMC’s end-2024 projection of a 2.6% yearly rise, on its projected glide path to 2.2% by the end of next year and onto its long-term target of 2% by 2026.
This may be as good as it gets, at least for now. “The relevant news is that recent inflation data are rising briskly,” writes Michael Lewis, who heads the Free Market Inc. advisory, in a client note on Friday. The three-month core PCE trend has rebounded to 3.5% annual growth, from under 2.5% in late 2023, he points out.
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Spending, meanwhile, surged 0.8% in February, despite personal income growing just 0.3%. The robust spending in excess of income growth set off concerns about consumers’ balance sheet, as the savings rate dipped to 3.6% in February from an upwardly revised 4.1% in the preceding month.
But, as Torsten Sløk, Apollo Global Management’s chief economist, continues to stress, the bull market has meant the asset side has boomed. Since the November FOMC meeting, when future rate cuts started to be discussed, the U.S. stock market has gained $10.9 trillion in value, while the bond market has grown $2.6 trillion. That combined $13.5 trillion wealth gain compared with total 2023 consumer spending of $19 trillion, he points out.
How can inflation be brought under control with the stock and cryptocurrency markets adding trillions of paper wealth? That’s the question posed by Marko Kolanovic, head of J.P. Morgan’s global market strategy team. And, as I’ve explained, the Treasury’s reduction of note and bond issuance in favor of short-term T-bills has neutralized aspects of the Fed’s quantitative tightening.
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“Historically, such loose monetary conditions are a significant driver of upside in [consumer-price-index] readings,” Kolanovic writes in a client note this past week. As a result, investors should be prepared for a period of higher rates for longer, he concludes.
Some market practitioners see fewer cuts by year end, from the current federal-funds target range of 5.25% to 5.50%, as indicated by the CME FedWatch site.
“One and done, and I’m not even sure about the one,” says David Hay, chief investment officer of Evergreen Gavekal, an investment advisor. Louis-Vincent Gave, the firm’s chief economist, wrote in a blog post this past week that the case for Fed rate cuts has been undermined by inflation topping expectations, the rise in gasoline prices, the breakout in gold to record highs, “feverish speculation” in crypto and parts of the equity market, the rise in bond yields, and the “rollover” in the dollar.
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Hay and Gave, along with many market observers, posit that the Fed may rather get one rate cut done in June, before the political conventions and the ramp-up in the presidential campaign. But looking at presidential election years since 1994, when the Fed started announcing policy changes publicly, Bespoke Investment Group found that the FOMC held rates steady 71.2% of the time and hiked them 15.3% of the time. When it cut rates, 13.6% of the time, it was in 2008 during the financial crisis and in 2020 during Covid.
One spur to a rate cut would be a weakening of the labor market, as Fed Chairman Jerome Powell indicated on Friday at a San Francisco Fed event, reiterating a comment he made following the March 20 FOMC confab. Lacking that, he affirmed that there’s no rush to ease while inflation remains on a “bumpy’ path.
Signs of worsening employment are scant. Initial claims for unemployment insurance remain at a historically low 210,000 per week. A new proprietary indicator from Vanguard Group shows that hiring actually has picked up recently, as demonstrated by enrollment in its 401(k) retirement plans. As for layoff announcements, especially among high-income workers in technology, it appears they’ve been able to find new jobs quickly, Vanguard adds.
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Labor market data due this coming week will be closely watched. Tuesday brings the February Job Openings and Labor Turnover Survey, or JOLTS, followed by the March employment report on Friday. Consensus guesses compiled by FactSet are for a 180,000 increase in nonfarm payrolls, down from 275,000 in February, which was tempered by 167,000 in downward revisions for the two prior months.
Taken together, a bottoming of inflation, a sturdy jobs market, and ultra-accommodative financial conditions exemplified by the S&P 500 index having its best first quarter since 2019, all undermine the consensus call for multiple Fed rate cuts.
Write to Randall W. Forsyth at randall.forsyth@barrons.com