Waller vs. Jake Paul?

Is Waller’s Fight with 2% Inflation Fixed?

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It turns out that Federal Reserve Governor Christopher Waller has quite an imagination. Waller described himself as a “MMA fighter who keeps getting inflation in a choke hold, waiting for it to tap out.” While he is as confident that “inflation isn’t getting out of the octagon,” his favored 3- and 6-month annualized measures of inflation hint at a re-acceleration of prices. Waller’s view that monetary policy is restrictive, pushing inflation lower but not significantly hurting employment, represents the dead center consensus among the Federal Open Market Committee (FOMC). He favors cutting 25 basis points at the December 17-18 meeting, and by extension, so do the rest of his FOMC voting colleagues.

Peeking into 2025, the imminent prospect of higher Chinese tariffs and higher wages resulting from Day One Executive Orders regarding immigration forms our base case that there will be no further progress on inflation. We expect rising inflation driven by higher inflation expectations as consumers see the extent of the price increases.

The market is always in search of change, as are we. The status quo at the Fed becomes disturbed if either:

·   The recent uptick in September and October inflation persists, putting the central bank’s 2% inflation target in question, or

·   Employment demand continues to deteriorate.

We expect the FOMC will reluctantly concede that the long term funds rate is higher than 3 percent as inflation proves to be fixed. This will contradict the Fed’s view that monetary policy is restrictive; unwelcome news for them, and for the equity market. The only way investors could see additional policy rate reductions may be if employment declines, which would be even worse news for equities.

Fast and Furious

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Trump is going to have a hard time staying within track limits if he plans to step on the fiscal accelerator. The new president is planning on gunning the engine as in his first term, but now, he is inheriting an economy in the later stages of growth than in 2016. Furthermore, the stock market is carrying a 50% higher valuation than it did eight years ago. Additional stimulus in this environment can backfire because he needs to generate higher investment to allow his Reganesque trickle-down policies to work. Increases to the current level of investment require stable long-term interest rates. That could be a problem for two reasons:

·   If growth picks up, real rates will rise, driving up nominal rates, especially at the longer end.

·   Treasury Secretary Scott Bessent may get into the driver’s seat and begin issuing more Treasuries at the long end of the yield curve.

No one is discussing this yet, but the February Quarterly Refunding Announcement (QRA) will be announced at the end of January 2025. Bessent has been critical of Janet Yellen issuing a record amount of U.S. Treasuries at the short end of the yield curve. If he decides to do the responsible thing and shift to heavier Treasury auctions of 10-year notes through 30-year bonds, investors will push yields higher. The last time Secretary Yellen tried that was in 2022, and 10-year yields rocketed from 2.5% on August 2 to 4.3% on October 21, 2022. That action caused a double digit revolt in stocks. How do you think the S&P Index, now trading at 31x earnings, will react?

Trump said yesterday on “Meet the Press” that he cannot guarantee consumers will not pay more as a result of tariffs. We are hearing straight talk from the new administration now that the election is over. If the incoming Treasury Secretary even suggests in passing that he may change the maturity mix of the upcoming quarter’s $825 billion securities refunding, investors will raise a yellow flag.

2025 Outlook: Will Japan Become Virtuous?

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We want to let you in on a secret: we love reading the reports from the Bank of Japan. They refer to things poetically, a welcome change from Western central banks; for example, they often refer to the “virtuous cycle of income to spending.” The hope has been that higher wages will spark spending growth, breaking the country’s deflationary cycle. First, deflation is not to be seen. Japan’s core inflation has remained above 2%  for over two years, setting the stage for a rate hike either at the Bank of Japan’s (BOJ) upcoming December meeting, or in January. 

Secondly, wages are up. Our favorite wage inflation indicator, Base Pay for Full-Time Workers, rose in October at the highest annual rate in 30 years. That pushed real wage growth (wages net of inflation) into positive territory, which bodes well for a pick-up in consumption. Third…well, there is no third. The problem is that household spending has not cooperated and has contracted over the last 18 months. That may make the BOJ wait for 2025’s spring labor union negotiations, which are expected to see an additional 5% wage increase.

The BOJ may be even more cautious than it is poetic, but if they decide to raise rates on December 19, it would mark an inflection point. It would give investors confidence that the central bank has faith that despite depressed spending and the potential for U.S. trade friction, the economy could weather its third rate hike. U.S. investors found value (if not virtue) in Japanese equities three years ago, with the TOPIX index outperforming the S&P 500 from Q1 2022 through Q3 2023. That move has all but reversed this year. We are watching for capital to flow from Japanese savings accounts into equities and for the U.S. capital to move back into Japan as an all-clear to move back into their markets in 2025.

What to Look for This Week

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1. Inflation:  No other data this week truly matters. Wednesday, December 11, and Thursday, December 12, at 8:30 a.m. E.S.T. will see the release of the key November inflation data from the Consumer Price Index and the Producer Price Index, respectively. Core CPI (ex-Food and Energy) requires a solid uptick above consensus expectations for a third consecutive 3.3% reading to shake the FOMC from cutting rates.

2. Post-election Expectations: The New York Federal Reserve’s Survey of Consumer Expectations for November is released Monday, December 9 at 11:00 a.m. E.S.T. This is a robust survey covering consumers’ views about inflation, the labor market, and personal finances.

3. China: Friday, December 13 at 5:00 a.m. E.S.T. November Chinese M2 Money Stock annual growth rate. Money growth fell by more than half from 12.9% in February 2023 to 6.2% in June 2024 before rebounding to 7.5% in October. Since Thanksgiving, Chinese equity markets have had a tepid rally. Investors want more evidence of added liquidity before resuming the one-month rally that started mid-September. Chinese stock indices have reversed 60% of that rally. We will also have our eye on New Loans for November; it is released with M2. Loan data has been unsurprisingly weak.

NOTE: We are in the two-week blackout period before the December 17-18 FOMC meeting, so there are no scheduled Fed speakers this week.