There Has to Be a Pony in There Somewhere

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Shangri-La 

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Soundbite: Shutdown? Bullish. Tariffs? Do not see them. Inflation worries? Gone. Growth? Unlimited. There is an absence of any “Wall of Worry” to overcome. As stated in other Three Pointers, rampant optimism cannot be sold without reason. A tipping point could arise over AI-related disappointment, either from capex or adoption issues, or even DeepSeek’s upcoming release. There certainly could be an inflation scare, but we can envision a classic fake-out involving employment. In the months leading up to the 2008 Olympics, Chinese Industrial Production was falling, but most dismissed it as temporary, attributing it to a need to reduce Beijing’s heavy pollution. However, the drop was not temporary and was, in retrospect, a great leading indicator for the 2008 recession. If our government shutdown results in a rise in unemployment, it will likely also be attributed to temporary factors. Nevertheless, there is a chance that there could be lasting damage, and investors are at risk of being fooled in the same way as they were in 2008.

Labor conditions are fragile at the same time as consumer demand could decline from the shutdown. If there is no quick resolution, investors are at risk of encountering weak job data and mistakenly interpreting it as temporary. This would be a recipe for ignoring valid recession signals. This tail risk becomes more of a possibility the longer the shutdown lasts. Under this scenario, serious doubts will eventually creep into the market for the first time in a while. One-sided market sentiment reminds me of President Regan’s joke about twin boys, where one is a pessimist and the other an optimist. A psychiatrist devises a scenario with a room full of toys for the pessimist in hopes of making him happy, but the boy refuses to play, convinced he will just break the toys. The optimist is put in a room with a huge mound of horse manure in hopes of dampening his spirit. Instead, he starts digging enthusiastically, shouting gleefully, “There has to be a pony in there somewhere!”

Investors expect solid earnings in a few weeks, a Fed convinced of its easing path, and deregulation and tax breaks that eliminate the chance of an economic slowdown. The problem is that the labor market is just hovering above ground, pressured by a low hiring rate. The unemployment rate was stuck between 4.0% and 4.2% during May 2024 and July 2025. That range was violated last month when August unemployment registered 4.3%, a new high. Whether the unemployment rate is only establishing a new tight range or beginning a sharp rise, what matters is that the employment situation may become problematic for investors.

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Batter Up: Laurie Logan and Slack vs. Slowing

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Soundbite: There will be four new FOMC voters in 2026, with only Neel Kashkari of the Minneapolis Fed favoring a series of rate cuts. Three of them lean hawkish, meaning they could become a roadblock to reducing rates, setting up a potential clash with the Trump FOMC appointees. Dallas Fed President Lorie Logan is one of the hawkish incoming voters, and her speech last week places her in opposition to Governor Stephen Miran. Whereas Miran is saying monetary policy is 200 basis points too restrictive, Logan asserts there “may be relatively little room to make additional rate cuts without inadvertently moving to an inappropriately accommodative stance.” Three incoming hawks could tip the balance away from Miran’s mission for immediate rate cuts. This complication could spark a sense of urgency within an administration impatient for the quick adoption of Miran’s views. The fight for Fed independence could be heating up, and markets may witness more conflict.

Dallas President Logan argues against Miran and other Committee members who think the Fed must cut rates preemptively to counter weak hiring. Logan warned that slowing employment in the face of contracting supply cannot be fixed by lower rates. Lower rates support demand, but she compared the current situation with the 1970s, when the “FOMC misinterpreted slowing productivity growth and GDP growth as increasing slack, and it lowered rates only to stoke inflation.” The fear of reliving the 1970s may be too strong to swing FOMC voters over to Miran’s camp. 

 We expect the change in the FOMC’s composition to move the Committee away from Trump’s plans for steady rate cuts. Assuming that happens, there is a strong possibility the president pushes even harder against Fed independence. If there is a more vigorous round of attacks on the central bank, the U.S. Dollar and long-term Treasury rates will also push back, creating volatile market conditions.

Miran is adamant that tariffs will be completely absorbed by exporters, thereby preventing any inflationary impact. Lorie Logan floated this rebuttal: “Shifting global supply chains and the re-shoring of manufacturing could continue to push up goods prices even after tariff effects are fully incorporated.”Therefore, she disagrees with Miran’s view on both inflation and employment mandates.

The lines have been drawn. We are dealing with irresistible forces and immovable objects.

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Stephen Miran: Gap and Go

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Soundbite: Stephen Miran does not believe he is an outlier at the Fed. He underscores the fact that his long-term rate cuts are consistent with the rest of the FOMC; he “just wants to get there faster.” Miran parts company with the time-honored central bank strategy of cutting rates cautiously in case it turns into a policy mistake. Miran sounded more like a hedge fund manager who realizes he is in a losing trade: “If policy is out of whack, you should adjust it at a reasonably brisk pace” otherwise restrictive policy risks a growth slowdown. We believe that he faces an impossibly daunting task to flip both the FOMC members' economic policy views and their approach to monetary policy. Unfortunately, this means the only way Trump gets the monetary goals he wants may be to turnover existing FOMC voters. 

Miran’s stated mission is to persuade his fellow FOMC voters to change their minds to his new way of thinking. The Trump appointee first hopes to make them realize that “rates are too high due to major changes in immigration and tariffs.”

We agree with Bill Dudley, former president of the New York Fed, who responds,” The Fed has plenty of reason to worry, but not enough to act.” We think the harder Miran pushes his agenda, the higher the risk it results in a more unified Fed that opposes his views. Miran’s quick-cutting schedule will run into strong opposition unless the economy quickly heads towards a recession. Miran could soon become frustrated, and that may invite intervention by the White House.

Open Market Committee members form their consensus after months of academic review and conversations with business leaders. Many of them fear potential stagflation. Given their dual mandate and open discussion, they will consider Governor Miran’s logic that “Positive effects of tax cuts get felt by production and increase economic growth. Negative effects of raising revenues from tariffs get borne by the exporters.” Hearing his argument is one thing, adopting it as their own is another.

First, his conviction over how necessary decisive rate cuts are ignores how uncertain the outlook is. Second, we believe there is a strong case against large rate cuts because GDP and equities are strong. We believe those two positions will sound more reasonable to the majority of the Committee than Miran’s arguments.

Again, all roads lead to greater conflict ahead.

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What to Look for This Week (Note that all data below will be released)

(All times E.S.T.)

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1. Wednesday, October 8 at 2:00 p.m. the Fed Minutes from the September 16-17 FOMC meeting are released. We will look for mentions of “one participant” to get more detail on Stephen Miran’s comments. Additionally, we will look for how often “couple” is mentioned regarding dovish commentary about weak employment to determine whether Bowman and Waller are more in Miran’s camp. The degree of consensus can also be revealed by a detailed reading.

2. Wednesday, October 8 at 7:00 a.m. Mortgage Banker Association Data for the week ending October 3. The MBA Purchase Index has been strong for the last four weeks, and the Refinance Index has spiked over the last three. We will focus on the Refi Index because it did come off last week from the extreme levels of the prior two weeks as the 30-year mortgage rate ticked up.

3. Friday, October 10 at 10:00 a.m. University of Michigan Survey of Consumers for October. Sentiment has fallen, but more importantly 5-year Inflation Expectations have moved up to 3.7% in September from 3.4% in July. Earlier in the week, on Tuesday, October 7 the New York Fed releases their Summary of Consumer Expectations for September at 11:00 and that will contain their one-, three-, and five-year readings on inflationary expectations.

FOMC Voters Speaking: Thursday, October 9 at 8:30 a.m. Fed Chair Jerome Powell speaks, followed by 8:35 a.m. Fed Governor Michele Bowman speaks, and we will be looking to see if she still believes we should “de-emphasize inflation” in monetary policy decisions currently. She speaks again Thursday at 3:45 p.m. Monday, October 6 at 5:00 p.m. Kansas City Fed President Jeffrey Schmid speaks about the economy and monetary policy. Tuesday October 7 Governor Miran speaks at 4:05 p.m. Wednesday October 8, St. Louis Fed President Alberto Musalem speaks. Friday October 10 at 9:45 a.m. Chicago Fed President Austin Goolsbee speaks, followed at 1:00 p.m. by President Musalem.

Earnings: Thursday, October 9, Q3 earnings season kicks in with Pepsi PEP and Delta DAL reporting before the market opens, but it is the following week when it gets in full swing with JP Morgan, Goldman, Wells Fargo and the rest of that at ilk next Tuesday October 14.

By Peter Corey

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