Hi everyone. I’m Liz Ann Sonders and this is the May Market Snapshot. As always, thank you for tuning in. On this month’s video, I’ll review the outcome of the most recent Fed meeting, as well as the latest details regarding the Fed’s dual mandates inflation and jobs.
[Cartoon for "Elevator up, escalator down" this time? is displayed]
It’s a well-worn adage that the Fed tends to take the escalator up when raising rates, and the elevator down when lowering rates. This refers to the tendency for the Fed to be somewhat methodical when raising rates, but more aggressive when lowering rates—particularly if the Fed is combatting a recession and/or financial crisis. Clearly, in this cycle, the Fed has flipped the proverbial script. Facing off against a pandemic-related spike in inflation, the Fed definitely, took the elevator up in this cycle—with the most aggressive tightening cycle in more than four decades—they raised rates eleven times, many of which were either 50 or 75 basis point hikes. In the interest of not repeating the mistakes of the fits-and-starts of inflation and monetary policy in the 1970s, I think the Fed may be eyeing the escalator on the way down whenever they get there.
[High/Low Chart for Thank you, “Goldilocks” May jobs report for Probability of Fed not cutting rates in 2024 is displayed]
On that note, prior to the release of the worse-than-expected April jobs report, investors had been keying off a few higher-than-expected inflation and labor cost readings. That led to a spike to more than a 25% probability that the Fed would not cut rates at all this year as you can see. What a difference a jobs report made, however. As you can see, that probability now stands at 10% as of this taping. That was driven by payrolls increasing by only 175k vs. the consensus expectation of 240k; and that was alongside the unemployment rate ticking up from 3.8% to 3.9%.
[High/Low Chart for What a difference a few months makes for Implied Fed funds target rate for 6/12/2024 is displayed]
So, what has that meant for the expected trajectory of the fed funds rate, set by the Fed? Let’s start with expectations for the next FOMC meeting, which concludes on June 12. As of January this year, it was expected that the fed funds rate would be as low as 4.5% by June, that suggested three-to-four rate cuts between January and June. That clearly has not panned out. As an aside, we were expressly skeptical of that rate cut enthusiasm back in January given that there really wasn’t anything in the data that suggested a green light for the Fed to start cutting so early in the year. As you can see now with the line’s trajectory, that expectation has adjusted since, such that there is presently a near-zero expectation of a cut at the June meeting.
[High/Low Chart for 7/31/2024, 9/18/2024, 11/7/2024, 12/18/2024 is displayed]
We can also build in the lines for the subsequent four FOMC meetings this year; which as you can see the direction very similar. As of this taping, and summarizing what these probabilities show, the market is presently pricing in a September start to rate cuts, with no more than two cuts expected. But as we have been pointing out, a data-dependent Fed means the data will dictate what has been a moving target of expectations.
[High/Low Chart for Tortoise beats the hare for S&P 500 Index Around First Fed Rate Cuts is displayed]
Let’s assume though, that last July’s rate hike was the final hike in the cycle … and that whenever the next move occurs, it will be a rate cut. In keeping with the perspective that the Fed is possibly eyeing the escalator on the way down, that by the way is not necessarily a bad thing as it relates to history. This data covers every Fed rate cycle since 1954 so the post World War II period and breaks them into slow, fast and non-cycles. What’s a non-cycle you’re probably asking? Well, those are periods when the Fed cut rates only once before reversing course and we don’t count those. Now the black line represents all cutting cycles, and you can see in the first row of the imbedded table that the market has historically had strong average performance once the Fed began cutting rates, especially in the first year. But check out the spread between the blue slow cycles line vs. the orange fast cycles line. Clearly, the best performance historically has come when the Fed moved more slowly—ostensibly because they were not hammering rates lower to combat a financial crisis and/or market crises like in 2007 and 2001; or brutal recessions like in the mid-1970s and early-1980s.
[High/Low Chart for Labor costs spiked again … uh oh? for Employment Cost Index is displayed]
For now, the Fed will continue to emphasize “patience,” that is its new buzz word. I am thinking that buzz word may have more shelf life than the Fed’s ill-conceived use of the word “transient” to describe the inflation problem when it erupted in 2022. Now, in deciding when it will be appropriate to ease policy, the Fed will not only analyze incoming inflation data, but the background conditions in support of those trends. One of those conditions is the broadest measure of labor costs, which is the Employment Cost Index, the ECI that’s what is shown here. After what was a fairly steady decline in the ECI from the peak in early 2022, the latest reading showed a somewhat disappointing uptick on a quarter-over-quarter basis. That’s in large part what led to that spike in the probability of no rate cuts this year, per the earlier chart that I showed.
[High/Low Chart for Quits rate suggests lower labor costs ahead for Employment Cost Index is displayed]
Now there is good potential news regarding the ECI looking ahead. Here is the ECI again in a line chart, this time showing the same data, but in year-over-year terms not in quarter over quarter terms. The growth rate has come down from more than 5%, but the fact that it remains above 4%, is still historically high.
[High/Low Chart for Quits rate is displayed]
But here’s an interesting comparison. Released within the widely-watched Job Openings and Labor Turnover Survey—for short JOLTS—it’s a metric called the quits rate, which calculates the percentage of workers voluntarily quitting their jobs. Now, with a bit of a lead time, the decline in the three-month moving average of the quits rate—from nearly 3% to now only 2.2%—suggests a lower ECI ahead … potentially good news from the perspective of the Fed.
[High/Low Chart for Inflation scenario exercise yields emphasis on “patience” for core CPI is displayed]
Now let’s bring this home with a look at what needs to happen to get inflation down to a level more palatable to the Fed. Now the Fed’s preferred inflation measure is the personal consumption expenditures price index; arguably the most widely-watched inflation measure is the consumer price index, or CPI, that’s what we show here.
[High/Low Chart for Constant Core CPI for 0.4%, 0.3%, 0.2%, 0.1%, 0.0% is displayed]
I decided to do an interesting math experiment—albeit a simple one. Each dotted line represents a scenario of monthly CPI readings and what they would mean for the CPI in year-over-year terms by the end of this year. Of course, the likelihood of consistent monthly readings for month after month is very low, but it’s a thought experiment, nonetheless. As you can see, it would take essentially consistent monthly readings of basically no change in the CPI to bring the year over year CPI to below 2%. The likelihood of that is not high; reinforcing the word of the day … or word of the year … that being patience.
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In sum, although higher-than-expected recent inflation readings have taken rate cuts off the table for near-term FOMC meetings, the softer-than-expected April jobs report has kept them on the table for later this year … at least for now. We do believe the Fed, for now, will remain patient, and when seeing the green light to ease policy, will likely do so at a measured and/or slow pace …and that’s a good thing historically for the stock market. Weaker job growth may be starting to flash green for the Fed, but the cost of labor is still flashing yellow. That mixed picture suggests patience will be a virtue for now. Thanks, as always, for tuning in.
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