Control Panel: They're doing it again

The asset markets became addicted to negative real interest for 20 years under Federal Reserve chairs Greenspan, Bernanke, Yellen and Powell. Some traders were probably in elementary school the last time the Federal Reserve actually allowed a semi-free market in the most important factor for a capitalist economy: the time value of money.

Since the Fed started raising the fed funds rate in 2022 to combat rising inflation the markets have been front-running a hoped-for return to free money.

Fed Chair Powell has been totally transparent about the Fed’s intention to maintain a “restrictive” fed funds rate until core PCE inflation is sustained at 2% for a substantial period of time. I put “restrictive” in quotes because the fed funds rate has not actually restricted the economy. Real GDP growth has continued well and U-3 unemployment is still under 4%.

The real fed funds rate historically was around 2%. The current real fed funds rate is around this level and is not actually restrictive. Despite market traders’ hopes, there’s no reason for the Fed to cut the fed funds rate. Options traders don’t see a cut until September at the earliest.

Despite this, market traders jump on any hint of possible GDP growth slowing to front-run the Fed’s eventual hoped-for cut in the fed funds rate. This has happened 3 times. Each time, bond yields drop and the stock market pops. Later, the markets realize the hoped-for cut won’t be advanced and the knee-jerk response vanishes.

In this market, good economic news is bad news and bad news is good news.

The Economic Slowdown Is Finally Here. Welcome It.

Services sector cools as consumers pull back, putting rate cuts back on the table

By Aaron Back, The Wall Street Journal, May 4, 2024

Evidence is stacking up that the U.S. economy has slowed, led by the formerly red-hot services sector.

Yet overall activity levels remain healthy, and some cooling is welcome news to investors because it opens the door back up to possible rate cuts by the Federal Reserve.

The most obvious indicator was Friday’s employment report, which showed the economy added 175,000 jobs in April, down significantly from 315,000 in March… [end quote]

Economic activity in the services sector contracted in April for the first time since December 2022, ending a period of 15 consecutive months of growth, say the nation’s purchasing and supply executives in the latest Services ISM® Report On Business ®. The Services PMI® registered 49.4 percent; it indicated sector expansion in 45 of the previous 47 months. The decline in the composite index in April is a result of lower business activity, slower new orders growth, faster supplier deliveries and the continued contraction in employment. Survey respondents indicated that overall business is generally slowing, with rates varying by company and industry. Employment challenges continue to be primarily due to difficulties in backfilling positions and/or controlling labor expenses. [end quote]

The services sector is about 70% of GDP. Most of their expense is labor cost. Although wage growth is dropping it’s still far higher than any time since 2008. Core and sticky inflation are still higher than the Fed’s goal.

Employment reports are often revised later. One soft employment report doesn’t mean the economy is actually slowing. The Atlanta Fed’s GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2024 was 3.3 percent on May 2. That is more than respectable growth.

Last week the stock indexes rose and the Treasury yield curve fell a little. The CAPE showed that the SPX is still in a historic bubble.

The Fear & Greed Index was in Fear. The risk trade was neutral. The USD was stable. Gold, silver, copper and oil prices fell a little. Natgas suddenly popped a little.

The Fed said on Wednesday that it would start slowing the pace of Quantitative Tightening in June, to $60 billion a month from a maximum reduction of $95 billion a month. This isn’t really news since they have announced their intention before. The Fed’s bloated book of Treasury and mortgage bonds will decline at an even slower pace. An article in the N.Y. Times describes the Fed’s QT policy and potential problems. But the bond market has already adjusted so I don’t think there will be an impact.

The METAR for next week is partly sunny. The markets will probably respond to the slight slowdown by advancing a little. But they’ve done this before. If the next inflation reading is high (which it likely will be since the strong economy is underpinned by government spending) it will reverse as it has before.




You rule! Great post, as always, but your observation on the possibililty of a mind blowing return to sanity in monetary policies is extra special.

There will be gnashing of teeth.

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I don’t know about gnashing of teeth. There will be some adjustments to current trading plans, but real problems. I suspect not.

Years and years ago when this was still Mish’s board and the Fed started playing by Calvinball rules, I gave the analogy of an engine with a carburetor. Then the Fed was flooding so much liquidity that the economy choked on it. Then when the economy finally got to the point it could use the fuel, it sped up so fast it spun the wheels. This created a lot of noise and smoke, but little forward movement.

It has taken a decade and a half, but the Fed finally let off the gas and the economy is starting to really create wealth. With employment approaching full employment,( unemployment only has to go up 20 percent more to have an efficient labor market), we should start seeing real productivity increases. You know, the right people in the right place at the right wage.

Also, it is becoming apparent that capital is valuable enough that it must be allocated well.

With energy priced about where it ought to be, labor priced about where it ought to be and capital priced about where it ought to be, the economy may be on the cusp of the greatest acceleration we have ever seen in living memory.

Of course traders that fail to understand this might have some gnashed teeth.