Federal Reserve Chair Jerome Powell and his colleagues often note the their dovish policy pivot this has been instrumental in supporting an economy subjected to numerous uncertainty shocks. The positive response of the housing market to lower interest rates supports that claim. New single family home sales came in ahead of expectations in August; the trend fairly clearly indicates that the sector has recovered from last year’s soft spot:

The housing sector is of course famously known as a leading indicator for the U.S. economy and hence the sector’s rebound would appear to indicate that recession fears are overblown. That said, remember that the 2001 recession had only a small housing component.  Just as manufacturing doesn’t seem to have the same connection to the overall economy as it did in the past, the same may be true for housing.

Separately, Federal Reserve leaders continue to struggle with their next policy move. Minneapolis Federal Reserve President Neel Kashkari thinks the Fed needs to get more aggressive. In an interview with The Washington Post, he argued that the Fed has placed the U.S. economy in a “dangerous position” with the 2015-2018 rate hike campaign that left growth vulnerable to negative shocks. Kashkari can “easily see justifying” rates being 50bp lower then now. Kashkari’s dovishness does not disappoint.

In contrast, Chicago Federal Reserve President Charles Evans, a voting member, implied that he was not looking for another rate cut just yet. Via Reuters:

“I think we are in a good place in terms of the rate setting,” Evans said. “We have adjusted in a much more accommodative fashion.”

Evans identifying himself as holding a “steady course” dot makes it more likely that the core of the FOMC voting members remain’s biased toward an additional rate cut between now and the end of the year. The next meeting is something of a toss up still with markets now setting 50-50 odds of a rate cut. The lack of a clear direction reflects uncertainty about how the Fed will view incoming data and news. Either the data needs to worsen to justify a cut or the data needs to improve to stop the core group of FOMC voters from pushing forward with another cut. Steady data is an unknown but odds favor a cut in that circumstance.

The housing data counts as a sign of improvement, but given the Fed’s focus on investment spending, I would anticipate them to be more responsive to further signs of weakness from the business sector than signs of strength from housing. Under this theory, this week’s most important release is Friday’s manufacturing orders report. Core new orders have held up well to date:

If that data reveals signs of substantial weakening, the conviction of the “we need another cut” camp will grow and the market odds should shift in that direction as well.

Bottom Line: With two rate cuts in the bag, the Fed is placing some extra emphasis in the data rather than the risks. The data could swing the October decision either way, though worth noting that a FOMC participant could both expect the Fed to cut rates again this year and pass on the October meeting. They can always follow up in December. 

I am a bit rushed for time this morning (this is a busy week traveling up and down I5 with events and speaking engagements in Albany, Salem, and Portland). Still, I wanted to take a minute to highlight some themes this week.

The central policy theme will be tracking data and risks to the forecast for insight into the Fed’s next move. Last week, the FOMC cut rates 25bp and left the door open for further cuts. In the post-meeting Pres conference, Powell was carefully not to give many hints on whether or not that meant another cut in October. Given the wide range of rate forecasts revealed in the Summary of Economic Projections, the next move is not obvious. Consequently, Powell emphasized the data dependent nature of the Fed’s decision making process.

My take – available via Bloomberg – was that the last two rate cuts were relatively easy calls for the Fed. The next move, however, is less obvious given that the data flow is holding up better than expected. The Fed remains caught between wanting to ease and stay ahead of any impending risks to the expansion while avoiding excessive easing that threatens to overheat the economy or create financial stability risks.  Fedspeak last week put the two viewpoints on display; see the Wall Street Journal here. Given the current firming in the data flow, it is reasonable to expect the Fed will hold in October with a risk that they ease. This scenario seems to fit with the current CME odds of a 55% chance of a 25bp cut.

Still, it is easy to tell a story that data and events evolve in such a way as to push the Fed toward another rate cut. Recent firming of the data may prove to be ephemeral, global growth isn’t looking too healthy, and trade remains a wildcard as do other geopolitical events such as Iran. Hence why the risks fall in that direction.

One important point: Although Powell appears noncommittal about the next move and I don’t think we really no what he is thinking, there may be a tendency for market participants to fall into the trap that he either doesn’t have control over the FOMC or that the lack of consensus among policy makers limits his choice set. I don’t think either is true. I think Powell enjoys support of the Board members, can easily bring on a couple presidents to his position, and that he doesn’t care if there is a consensus as long as he is getting the policy right. In other words, I think Powell can get what he wants, so don’t underestimate his willingness to move as he sees fit. He doesn’t need to build a consensus.

In other news, last week’s repo excitement appears to have settled down. There was a ridiculous amount of very bad and sensationalistic analysis floating around the web. This for example:

UPDATE: The NY Fed is planning to inject another $75 billion into the financial system on Friday (tomorrow).

That will be more than $275 billion total in four days this week.

Add in the two recent rate cuts & you could argue that the Fed is fighting the start of a recession…

— Pomp 🌪 (@APompliano) September 19, 2019

We all know you don’t total up repo operations as they are by definition temporary and reversed, right?  The “bailout” theme is pervasive last week:

As you may suspect: This is Not Great. The Fed is basically supporting the most essential market that supports day-to-day banking. It’s fair to call it a bailout. But we still don’t know the real causes. https://t.co/tKNt1UGAPz

— Heidi N. Moore (@moorehn) September 20, 2019

Nope, not a bailout, and supporting these markets is one of the Fed’s jobs. It’s how they manage short-term policy rates.

The basic story is that even though the Fed knew they could run up against scarce reserves, they were still caught off-guard, and their slow response gave the impression that maybe something was wrong. There wasn’t and they were able to address the situation by returning to the pre-crisis central banking. Over the longer run, they will look for a longer term fix such as a standing repo facility or fresh POMOs to expand the balance sheet. In short, this isn’t the crisis you were looking for.

Bottom Line: Wait and see.

I am seeing some questionable commentary. Like this via Bloomberg:

Relying on repo operations doesn’t resolve the issue of reserves declining as the Treasury rebuilds balances, Hornbach wrote in a note. Having regular operations will also increase market uncertainty as the Fed could halt purchases at any time, while the size of its buying will have to expand over time as reserves drop, he said.

Seriously? The Fed isn’t going to randomly halt the repo operations. And yes, they are going to keep increasing the size of the purchases if needed. And if the shortage continues, the Fed is going to boost reserves via permanent open market operations, the dull as dirt balance sheet expansions that happened like clockwork prior to the crisis. Similarly, also this via Bloomberg:

“The next 11 days are going to be a disaster,” Simons said. “If you stack up on both sides the arguments for repo going higher again, it’s all of these things that drain cash out of the market that are persistent issues or unknown but could be persistent. Where are the arguments for repo going lower?”

The arguments for repo rates going lower are 1.) that the Fed just cut the federal funds target by 25 basis points and the IOER rate by 30 basis points, 2.) the Fed can pump as much money as they need to into the markets via repo operations, and 3.) the Fed can expand the balance sheet if they need to.

The Fed is doing the right thing here, using the tools they designed for exactly this purpose. For the most part this is old school central banking. People need to stop living in the last crisis.

That doesn’t mean the Fed is without fault here. Part of the reason for this confusion is that the New York Fed wasn’t on top of this on the morning of day one. The delay made it look like this was some kind of emergency rather than standard operating procedures. Why was the New York Fed slow in responding to evolving market conditions? That’s the story here!

Maybe, just maybe, the slow reaction is the result of eliminating the institutional knowledge. Recall that New York Fed President John Williams shook up his staff earlier in the year. Via Bloomberg:

The sudden departure of two longtime officials shook staff, sank morale and drew attention to the leadership of the New York Fed under John Williams as he enters his second year at the helm. On Wall Street, questions arose again a couple of weeks ago when a speech he gave inadvertently whipsawed markets.

The story involves Simon Potter, who ran the all-important markets desk, and Richard Dzina, head of the financial services group. Both were abruptly relieved of their roles in late May by Williams. Little explanation was given, but according to current and former New York Fed employees, as well as those close to the bank, the nature of the exits, by fault or design, seemed to be a warning: fall in line

The New York Fed plays a powerful role. It is the central bank’s eyes and ears on Wall Street. And as the only regional bank with a permanent vote on rate decisions, it has outsize influence in the financial system. The selection of Williams, a widely respected and oft-cited monetary economist who ran the San Francisco Fed for seven years, for the top job in New York raised eyebrows from the outset. A finance-industry background has traditionally been seen as a key qualification, something he lacked.

Williams, who during his San Francisco Fed days often mentioned his reluctance to pay too much attention to short-term swings in the markets, came under fire on July 18 after saying in a speech that central banks should act quickly “at the first sign of economic distress.”

Yes, well maybe those short term swings in some markets are important. IMHO, financial journalists are chasing the wrong story here. It isn’t that the New York Fed is doing their job with the repo operations. It’s why they weren’t doing their job earlier.

While we are the topic of criticizing the Fed, I am hearing a lot of commentary complaining that Federal Reserve Chair Jerome Powell isn’t in control of the Fed. The supposed evidence is the three dissents at the last meeting which signals a lack of consensus.

Consensus is overrated. I suspect that Powell feels the same way. Responding to a question from the Wall Street Journal Nick Timiraos, Powell said:

Well, let me just say, on the general point of diverse perspectives, you’re right, sometimes, and there’ve been many of those times in my now almost eight years at the Fed, many times when the direction is relatively clear and it’s relatively easy to reach anonymity. This is a time of difficult judgments, and as you can see, disparate perspectives. And I really do think that’s nothing but healthy. And so, I see a benefit in having those diverse perspectives, really.

I don’t think Powell is worried about generating a consensus. And I don’t think he should be worried. Think about the current situation. We clearly know whose opinion isn’t gaining traction, and hence whose opinion we don’t have to spend a lot of time fretting over. And we also know that the FOMC isn’t setting policy to make those people happy, or twisting the policy statement to get their vote. No one is tossing them a bone to get them to come on board with the consensus. This isn’t a bad thing. We are probably getting cleaner policy because it doesn’t have to be the typical product of a committee, something that is fundamentally designed to make everyone on the committee happy.

Also hearing commentary that Powell isn’t a good communicator, and not just from President Trump. So on this point, sure, Powell’s conversational, off-the-cuff style hasn’t always been the best for the job. We, including myself, will tend to read too much into errant remarks, largely because we all worry that we are on the wrong side of the call and no one likes to be on the wrong side of the call. That said, I think a fair comparison of this week’s press conference with the last reveals that Powell is modifying his approach. This week he appeared to anticipate questions much better than in the past and not start some story like “mid-cycle adjustment” that forced him to back up over himself and then turn back around. It was a clean, solid performance.

The only question that I thought received a less-than-satisfactory answer was that by the Washington Post’s Heather Long:

Hi, Heather long from the Washington Post. Mr. Chairman, in your view, is there any risk to the United States having much higher interest rates than Europe, and Japan, and other parts of the world? Is there any risk to the U.S. Economy to that divergence or any risks to the global economy?

The dollar is a critical element of the global financial system. My instinct is that the Fed can not set rates higher than the rest of the world without stressing the entire system. I think the Fed needs to think about this more, at least that was my response to Powell’s answer.

Bottom Line: There’s valid criticism of the Fed, and there’s invalid criticism. I worry that the apparent dominance of latter drives overly bearish conclusions.

Note: Last week, the subscriber service was shutdown for this blog due to technical difficulties. We should be up and running again now.

My recap of yesterday’s FOMC meeting is up on Bloomberg this morning:

The Federal Reserve has now lowered its target interest rate for overnight loans between banks twice since the end of July. The central bank’s economic projections and Chairman Jerome Powell’s post-meeting news conference suggest policy makers aren’t quite ready to cut rates a third time, and will need to see either weaker economic data or an intensification of the U.S-China trade war to deliver that cut….

Continued at Bloomberg Opinion…

Newsletter version!

If You Don’t Have Any Time This Morning

The Fed will cut rates 25bp next week and leave the door open for more. It is reasonable to argue that they need to cut 50bp. If that’s what they should do but won’t, adjust your forecasts down accordingly.

Key Data

The employment report for August 2019 revealed a slowing albeit arguably solid labor market in the U.S.Nonfarm payrolls grew by a somewhat softer than expected 130k, but that number was inflated by the addition of 25k temporary Census workers. Both June and July experienced modest downward revisions. Including Census workers, job gains are running at a 156k average monthly pace over the past three months. Importantly, the pace of gains remains above that which the Fed believes is consistent with steady unemployment. Still, the unemployment rate has been in the 3.6-3.7% range for five months now.

Wage growth surprised on the upside with a 4.8% annualized gain in August; the overall trend is 3.0-3.5% annual wage growth. Hours worked edged up and temporary employment made a solid gain for the month but the overall trend is a weak 1.7k monthly gain on average over the past year. Prime age labor force participation jumped back up; overall participation has basically flatlined since 2016.

One take on the numbers is fairly positive. The economy continues to generate jobs at a pace sufficient to either lower unemployment further or encourage more people to enter the labor force. The jump in wage growth might even suggest that the economy is finally bumping up against full capacity and that is the primary culprit behind slower job growth. And maybe the August jobs number is revised up. Another take is less positive.The job market has clearly slowed, and, after accounting for the Census hires, may have slowed very close to the point where unemployment at best holds steady. That significant downshift in momentum is very worrisome. The second derivative here is not our friend. Moreover, don’t take too much comfort in the stronger wage numbers as that can easily be a lagging variable; wages might not take a hit until unemployment starts rising.

See here for comments on manufacturingfrom last week. Note that GDP tracking measures from the New York and Atlanta Federal Reserve Banks are both at a below trend 1.5% for the third quarter. New York is looking at 1.1% growth for the fourth quarter. Most definitely nothing to write home about.

Fedspeak

Split opinions on the next policy move from policy makers. St. Louis Federal Reserve President James Bullard now wants the Fed to listen to market participants and deliver a 50bp cut at next week’s meeting while his colleague Boston Federal Reserve President Eric Rosengren thinks the risks to the forecast need to become reality before further rate cuts are justified. New York Federal Reserve President John Williams argues“[t]he economy is in a good place, but not without risk and uncertainty.” Importantly, he adds this:

An additional fly in the ointment, if you will, is the recently released downward revision for GDP growth covering last year and an announced estimate of a sizable downward revision to payroll employment. One implication of these revisions is that the economy’s underlying momentum was already somewhat less robust than previously thought, even before recent developments pointed to a less rosy outlook.

Last year’s rate hikes, especially December’s, assumed greater economic momentum than was actually the case. Not only that, but whatever momentum the economy had then dissipated more rapidly than expected. That means the Fed needs to both roll back some of last year’s hikes and address the increase in economic uncertainty.

From Switzerland, Federal Reserve Chair Jerome Powell commented on the U.S. economylast Friday. His emphasis on the risks to the outlook reinforced expectations that the Fed would ease at next week’s FOMC meeting.Powell also argued that the outlook for the economy remains favorable because the Fed has shifted the expected path of policy rates downward. An implication of that shift is that the Fed needs to ratify those expectations with lower policy rates or risk an unwanted tightening of financial conditions. Still, he gave an upbeat assessment of the economy, commenting on strong labor markets and taking the positive view on the August employment report. Powell also noted that inflation is heading back to 2%. That fairly positive outlook dashed any hopes that the Fed would cut 50bp at the next meeting.

Federal Reserve economists attempted to quantify the impacts of trade policy uncertaintyon the US and global economies. They estimate that the first and second waves of trade disputes that have hit the economy will slice over 1% off U.S. GDP by 2020. By this argument, trade disputes are not a potential risk for the economy but instead they are already having an impact, further justifying the easing bias taken by Powell & Co.

Upcoming Data

A reasonable amount of data to think about coming this week. JOLTS on Tuesday, PPI on Wednesday, CPI and initial claims on Thursday, and retail sales on Friday. The inflation data is arguably the most important; if the Fed doesn’t fear inflation, then they can hold their dovish bias. The game becomes much more interesting if inflation heads for 2.5% or higher.

Discussion

The Fed is going to cut rates by 25bp at next week’s FOMC meeting and leave the door open for further rate cuts. One could make the argument that the Fed should just get it over with and fix the yield curve with a 50bp cut. I would be inclined to make a 50bp cut to get ahead of any further deterioration in the labor market. The Fed is not so inclined.

The Fed tends to avoid large rate cuts unless either the data is clearly falling off the cliff or credit markets are seizing up. Neither is currently the case. The data flow remains inconsistent with a recession while the corporate bond market is on fireand U.S. equities could soon see record highs. The Fed will find it difficult to cut rates 50bp in such an environment. Instead, the Fed will take a more cautious approach to policy, pushing down rates in quarter point increments.

Also, the Fed will tend to resist large moves because they do not want to be caught wrongfooted by a surprise improvement in the global economy or a thawing of trade tensions. They surely see how the market rallies on positive trade news and will fear that excessively cutting rates now will set the stage for financial instability or economic overheating if trade tensions rapidly dissipate. To be sure though, should a major negative trade or global event like a hard Brexit occur that make the risks all too real, the Fed would respond with a large hike cut.

I think the most likely path forward for policy after next week is another rate cut in October. I don’t think the trade uncertainty will dissipate sufficiently between now and then to alleviate the Fed’s concerns, nor is there likely to be a sudden improvement in the data flow.

What about more than a total of 75bp of easing? Could it be 100bp? Or 125bp? That’s an interesting question. I currently tend toward a fairly bimodal outlook. Either 75bp is enough action to, as the Fed says, “sustain the expansion,” or the economy will slip into recession and the Fed will push short rates back to zero.At this time, I am having trouble seeing much room between those two outcomes. I remain optimistic however that the economy will follow the first path.Again, it is worth repeating that although the yield curve has inverted, the Fed would typically still resist policy easing at this point in the cycle. Indeed, I think the Fed’s early shift has already yielded some positive results. See, for example, homebuilder stocks.

Still, following the logic of the on-again, off-again advice of Williams, with a 50bp cut the Fed would maximize the chance that they sustain the expansion.I think the Fed would be better off getting some momentum behind the economy now rather than waiting until risks to the outlook actually materialize. There are far too many risks to the outlook to expect they all dissipate easily. Policy uncertainty isn’t going away and will likely increase. Market participants should take note of the increasingly erratic behavior of the White House.You know what I am talking about. And it’s not just trade policy that should be of concern; don’t forget regulatory uncertainty and festering sores in the geopolitical arena (North Korea, Iran).

Bottom Line: The Fed will cut rates 25bp next week. I don’t think everyone will be happy about it; anticipate dissents. Still, don’t focus on the dissents. I get the sense that Powell is more interested in getting policy correct than forcing policy into something that achieves consensus but is not correct. I think the Fed should pull the trigger on 50bp; they are most likely going there anyways and should just get it over with. The Fed, however, will have a hard time ignoring a data flow that they see as still generally solid. Really, it is kind of a small miracle that they pivoted toward easier policy at all.

Hopes for a big rate cut at the upcoming FOMC meeting took a hit after today’s data releases. To be sure, the game is arguably not over as we still have tomorrow’s employment report ahead of us. Realistically though it is not likely to be sufficiently weak to drive the Fed to a 50bp cut. And, considering sentiment, there is arguably a case to be made that a sufficiently strong report would cast doubt on any rate cut at all.

In contrast to the soft manufacturing ISM report, its service sector cousin was more upbeat. The index rose more than expected on the back of strong gains in the new orders and activity components. The employment component fell but remains above 50. It looks like the service sector of the economy is diverging from the manufacturing side of the economy much as we saw in 2015-16:

To be sure, that story could change. Still, it continues to be that case that the global growth and trade shocks are primarily striking the manufacturing side of the economy. That side of the economy may now be too small to easily transmit recessionary shocks to the rest of the economy. And if these shocks are not sufficient to generate a recession, then the Fed will not be taking rates back to zero anytime soon.

Initial unemployment claims continue to move sideways:

while ADP reported that the private sector added 195k jobs in August. My estimate for job growth is 155k, basically the same as the consensus of 158k:

Two notes of caution though. First, the headline might be higher than expected due to Census hiring, so adjust accordingly. Second, August might be revised upward. See Calculated Risk on both topics.

As of this moment, CME reports odds of 95.8% that the Fed cuts rate 25bp while a 4.2% chance that they hold steady. Earlier in the week the choice was cut 25bp or 50bp but flipped on today’s data. It is reasonable to believe that a solid employment report with upward revisions to August further raises the odds of no cut this month.

I believe the Fed will cut 25bp even if the employment picture remains bright. The risks to the outlook remain, business investment has not yet rebounded, upcoming revisions to employment data indicate the economy had less momentum than believed, market participants anticipate further easing, and another rate cut would help address the yield curve inversion. Still, ongoing upside surprises to the data would encourage the Fed to take a more hawkish stance beyond this next meeting.

Bottom Line: Fed will likely cut 25bp this month. The data is not screaming for 50bp. Some might argue that it is not screaming for 25bp either, but it still looks like cheap insurance against the possibility that watching the data now is too much of an exercise of driving through the rear view window. 

The ISM report for August revealed that the manufacturing sector continues to struggle under the weight of trade wars and weak global growth. Headline and key internal numbers all slipped below 50 in September:

Importantly, this is the third trip below 5o since the end of the last recession; a manufacturing recession does not necessarily imply a US recession. Note also that in the last recession, the bottom fell out of manufacturing well after the recession officially began. My interpretation is that the causality flowed from the rest of the economy to manufacturing rather than vice-versa. In other words, if this is a primarily manufacturing shock, we still might not see it spill into the rest of the economy. That said, this is the ISM’s first trip below 50 since the last recession that coincided with an inversion of the yield curve. That’s a little bit more disconcerting.

The anecdotal comments in the report were considerably less worrisome. This in particular struck me as summarizing the general mood in the economy:

“Generally, business remains steady. However, we continue to plan for a hard Brexit and a long trade war between the U.S. and China.” (Miscellaneous Manufacturing)

My sense from talking with firms is they were already concerned about the sustainability of the expansion as it approached 10 years of age for no other reason than they didn’t think it could go on forever. The recent trade wars and the well-publicized relationship between yield curve inversions and recessions have intensified those concerns. We should be wary of such intensifying pessimism spreading throughout the economy.

Speaking of trade wars, the international side of the ISM report is looking particularly weak:

The export orders index looks like it is in free-fall, likely reflecting the dual impacts of weak global growth and retaliatory trade policy. Again, this is a test of how much the manufacturing sector and it’s external linkages drive the business cycle. At what point do these factors directly trigger a broader U.S. downturn? At what point to worries alone about these factors trigger a downturn?

Financial market participants already viewed a Fed rate cut this month as a done deal prior to this data. This data though does elevate the probability of a 50bp cut. I think the Fed will tend to be loathe to cut rates 50bp given still solid overall numbers. See, for example, the strong consumer outlook as reported last week:

The Fed will place more weight on this week’s employment report than the ISM numbers. If employment stays reasonably strong, they will likely opt for the smaller rate cut.

Bottom Line: Weak global growth and Trumpian policy uncertainty continue to weigh on the economic outlook. The Fed will respond with lower interest rates. Absent weaker data beyond manufacturing, though, the Fed isn’t going to be happy about cutting rates and will resist a 50bp cut. Assuming a solid employment report, I anticipate continuing push-back from regional Fed presidents and another split vote at the upcoming FOMC meeting.