The Path Not Taken

FOMC, Tell Me Why?

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The FOMC meeting surprised 104 of 109 economists who had expected a 25-basis point rate cut but got 50. This, of course, raises the question of why they cut the Fed funds target by 50 basis points. The answer has two parts. 

First, buried in the back of the September quarterly Summary of Economic Projections (SEP) is a comparison between the June and September forecasts. There was a clear shift higher in the Federal Open Market Committee’s (FOMC) 2024 unemployment estimate over the last three months. Specifically, in June, only one of nineteen FOMC members thought the unemployment rate would end the year above 4.3%, but in September, that number jumped to ten of the nineteen members. Only four members thought the unemployment rate risks were weighted to the upside in June, but in September, that number had tripled to twelve. So, when the FOMC statement said, “the risks to achieving its employment and inflation goals are roughly in balance,” don’t believe them. They are far more concerned about unemployment, so they stepped on the accelerator and moved 50.

The second reason for surprising the market was the August inflation data released the week before the FOMC meeting. Fed Governor Waller was on CNBC Friday explaining that the CPI data was why he shifted from voting for a 25-basis point cut to deciding on 50. When we looked at the data, housing inflation’s problematic rise to 5.2% led us to the conclusion that there was insufficient data to support a 50-basis point rate cut. 

In retrospect, the FOMC must have focused on core CPI ex-shelter inflation of only 1.7%. We believe this is a false hope that shelter inflation will drop down to 2%, helping the central bank reach its inflation target. They believe that is a foregone conclusion, affording them the ability to ease aggressively to support the downside risks of employment. The FOMC perceives upside inflation risks to be at their lowest level in almost four years. Therefore, the prevailing view among the voters is that a bigger than expected rate cut won’t be inflationary.

We believe that, at best, housing inflation and services inflation are hitting a trough and will begin to move up from here. The fact that the Fed cut rates by 50 basis points now makes their inflation fighting job that much harder in the future.

So Now You’re a China Bear?

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When a long-time bull throws in the towel, that is the time to get bullish. Ray Dalio of Bridgewater Associates has been an outspoken advocate of China’s economic miracle for years. Last week at the Milken Conference, he changed his tune, saying the country is in dire need of restructuring because it is mired in “a situation that is more challenging than Japan in 1990.” Drawing a connection to 1990 Japan is extremely bearish because it shows that he is worried about China entering a multi-decade deflationary cycle that is analogous to the one from which Japan has only now recovered. Nonetheless, Dalio said, “China remains a very attractively priced place to invest”  and “we will stay in China through this process.” Perhaps we should wait for news that Dalio has fully liquidated his investments before turning confident that a Chinese market bottom is at hand.

Meanwhile, the Chinese yield curve just inverted, with shorter maturity interest rate swaps now yielding above longer dated swaps. This reflects a recessionary forecast. Not only are consumption, manufacturing, and foreign investment falling, but retail investors have pulled back and are hoarding cash. The fact that Chinese citizens are retreating from capital markets means they are questioning Beijing’s ability to shepherd the economy through this downturn. It is difficult to turn that loss of confidence around quickly. As contrarians, however, this makes us look closely for an inflection point as the opportunity in China will come.

If at First You Don’t Succeed, Try the Same Thing?

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T-Minus 7: D.C. is locked into a dual collision course: keeping the government open against the clock and Republican congress members facing re-election against Donald Trump.

With a week to go before the government shuts down on September 30, House Speaker Johnson is sticking to his strategy to link the government funding bill with a voting registration bill despite its second failure to pass last Wednesday. There appears to be no way to garner sufficient votes to pass funding legislation that keeps these voter verification measures. However, right before the combined bill went to the House floor, President Trump posted that GOP voters should shut down the government unless voter verification was also passed.

Trump's power over the party may be tested this week if moderate House and Senate Republicans reject the former president’s desire to provide proof of U.S. citizenship before voting. Republican members of Congress are growing concerned that they will jeopardize their re-election prospects if the Continuing Resolution is not passed, which will trigger a shutdown. They may decide to act in their own self-interest by compromising and rejecting Trump’s directive. Republican minority leader Senator Mitch McConnell said, “It would be politically beyond stupid for us to [shut down the government] right before the election because certainly, we would get the blame.” The next few days will shed light on the power dynamics in Washington, affecting markets and the election. 

Last minute Sunday, Speaker Johnson abandoned a longer-term deal and opted for a 3-month stop-gap measure that both parties can agree to that eliminated the proof of citizenship clause.

What to Look for This Week

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1. Friday, September 27, 8:30 a.m. E.D.T. Personal Consumption Expenditures Price Index for August. The PCE inflation report will get scrutinized because Fed Governor Waller said the information in the CPI and PPI reports led him to believe that August core PCE will come in below consensus at just .14% m/m. The quarterly annualized inflation will be a very low 1.8%. Core PCE has been 2.6% y/y for the prior three releases.

2. Fed speak: Tuesday, September 24, 9:00 am E.D.T, Fed Governor Michelle Bowman speaks about monetary policy. It is important because she was the only dissenting voice at the September FOMC vote. She speaks again on Wednesday, September 25, at 9:15 a.m. E.D.T. and Friday (1:15 p.m. E.D.T.). Chairman Powell speaks in a prerecorded video on Wednesday giving opening remarks, but that will be a non-event. Governor Adriana Kugler speaks at 4:00 p.m. E.D.T. Wednesday September 25 and 9:10 a.m. E.D.T. Thursday September 26.

3. Thursday, September 26, 8:30 a.m. Initial and Continuing Claims. Our focus is the 4-week moving average of Initial Claims, which has fallen over the past 6 weeks. It was last at 227,500, the lowest level since May. This series is moving in a better direction, which runs counter to the Fed cutting 50 basis points over labor market concerns. 

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By Peter Corey

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