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The Big Picture
Last Updated: 09-Jun-23 10:45 ET | Archive
Fed and economy are engaged in a tough squash match
The Conference Board's Leading Economic Index declined 0.6% in April, marking the 13th consecutive decline in that series, and signaling, according to the Conference Board, a worsening economic outlook. The Conference Board's Consumer Confidence Index for May featured an Expectations Index that slipped to 71.5, continuing a string of sub-80.0 readings in every month since February 2022, except for December 2022. A reading below 80.0, the Conference Board says, is associated with a recession in the next year.
The PCE Price Index increased to 4.4% year-over-year in April from 4.2% in March. The core-PCE Price Index, which excludes food and energy, increased to 4.7% year-over-year from 4.6%. That is the Fed's preferred inflation gauge, and it is moving in the wrong direction.
The Consumer Price Index, for added measure, showed total CPI up 4.9% year-over-year, versus 5.0% in March, and core CPI up 5.5% year-over-year, versus 5.6% in March. Clearly, CPI moved in the right direction, yet that did not excuse the fact that consumer inflation is still too high -- certainly relative to the Fed's 2.0% inflation target.
Hard Landing or Soft Landing?
It will surprise no one to hear that recession concerns are part of the market narrative, but to be fair, there has been some burgeoning optimism that a hard landing for the U.S. economy can be avoided. That optimism has been rooted in the ongoing strength of the labor market.
No one, however, is really looking for a boom in economic activity. The choice is between a hard landing and a soft landing. The latter is winning out these days in the stock market, which is trading at its best levels since last August but still adhering to a 13-month trading range.
A word that has been creeping into the market narrative, however, is stagflation. That term is used to describe a period when high unemployment and stagnant demand is accompanied by high inflation.
We have high inflation now and we are hearing increasingly that demand is moderating due to macro pressures, but we do not have a high unemployment rate. Granted the May unemployment rate moved to 3.7% from 3.4% in April, but 3.7% isn't high. In the recessions seen since 1980, the average unemployment rate has ranged from 4.8% to 9.0%.
The Fed, of course, seems wedded to the idea that a further softening in the labor market is needed to help bring inflation back down to its target rate on a sustainable basis. That would suggest the Fed is not done raising rates given the resilience of the labor market or, at the least, won't be cutting rates anytime soon as it waits on the lag effect of prior rate hikes to squash demand and the labor market.
Home on the Range
Like the stock market, the Treasury market has also been locked in a trading range for the past nine months, tossing and turning on inflation data, rate hike expectations, a mini banking crisis, debt ceiling uncertainty, and fickle economic views.
Treasury yields today are a far cry from where they were only 15 months ago when the Fed started raising its target range for the fed funds rate from 0.00-0.25%. Today, the target range is 5.00-5.25%. The fed funds futures market is not expecting a rate hike at the June FOMC meeting, yet that view could be subject to quick change pending the June 13 release of the May Consumer Price Index. In any case, there is currently a 67.0% probability of a 25-basis points rate hike at the July FOMC meeting.
What It All Means
The question of course is, will prior rate hikes end up squashing demand that, in turn, squashes the labor market and inflation? Or will prior rate hikes squash demand while structural forces lead to continued strength in the labor market and the persistence of high inflation?
The answer will reverberate across capital markets, but if the Fed finds reason to stay higher for longer with its policy rate, then Treasury yields will be poised to stay higher for longer, respecting their current trading ranges or something worse that will remain a competitive headwind for stocks.
-- Patrick J. O'Hare, Briefing.com
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