Quickly commenting on some responses to my piece yesterday. First, from Steve Matthews at Bloomberg:

Interesting, I hear Fed folks talk all the time about payrolls (and unemployment rate and average hourly earnings) but it’s rare you hear anyone talk about ISM.

— Steve Matthews (@SteveMatthews12) November 26, 2018

That comment brought up a point that I did not make sufficiently clear. We don’t regularly hear Fed officials highlight a signal data point and say “if it hits this level, we will respond like this.” And we shouldn’t – it’s really about the constellation of the data. From my perspective, the ISM report often quickly reflects a shift in the underlying data, allowing me to create a shorthand version of what prompts changes in the Fed’s policy stance. A combination of data that usually does the trick is weak ISM, weak payrolls numbers, and low inflation.

One commenter derided me as out of touch with the times:

That’s so 90’s. Name a fed speaker who has mentioned ism in the last 15 years ?

— RideTheWave (@tenerife444) November 26, 2018

What can I say? I love classics (and I suspect that we are beyond the choppier data flow of the Great Recession era). I can’t even publish my Spotify playlists for fear of public ridicule. Seriously though, see above. I am not saying that Fed Chairman Jerome Powell would be foolish enough to publicly or privately hinge policy on a single variable, but under most conditions a shift of that variable coincides with shifts of economic activity that prompts the Fed to change course.

Finally, via email I received comments questioning the value of the ISM measure during the late 90s, a period of solid growth despite low ISM readings:

Note that I did not say that the ISM number was by itself a great recession indicator, only that is tended to correspond to changes in Fed policy. And this era was no exception. 1997 and 1998 were the time of the Asian Financial Crisis, LTCM, a yield curve inversion, and predictions of recession due to a fall in US exports. And the Fed’s response was to cut interest rates. Here is the ISM chart with timing of Fed policy easings:

Bottom Line: Market participant’s attitude about the path of rate policy have shifted dovishly in recent weeks. So far, the data flow does not support such a dovish shift. If those who foresee a significantly darker future are correct and December is truly the last rate hike, you will see the data soon turn. What would that turn look like? I suspect that, in a nutshell, it would entail a sharp drop in the ISM index, weak job growth, and sustained low inflation. If I saw those things happen, I would say that the odds of the Fed skipping a hike in the first quarter of 2019 are quite high.