Weekly Research Briefing: Half or Quarter?

The two objectives of the Fed’s dual mandate — price stability and maximum sustainable employment — have come into much closer balance, suggesting that monetary policy should be neutral, neither restraining nor boosting economic activity. Yet short-term interest rates remain far above neutral. This disparity needs to be corrected as quickly as possible.

Consider the economic data. The unemployment rate has risen by 0.8 percentage points from its trough in January 2023. In the past three months, payroll employment has increased at the slowest pace since 2020. Wage inflation has moderated to less than 4%, while the Fed’s preferred measure of consumer price inflation is running around 2.5%. Although core consumer prices rose a bit more than expected in August, the move was driven by categories that tend to lag (insurance and shelter), and the latest producer price report suggests that the core personal consumption expenditures index will be considerably tamer.

One could even argue that the downside risks to employment outweigh the upside risks to inflation. When the labor market deteriorates beyond a certain point, the process tends to be self-reinforcing. Every time the three-month average unemployment rate has risen by more than 0.5 percentage from its low point during the prior 12 months, the ultimate result has been much larger increase — at least 1.9 percentage points — and a recession. The threshold might be higher this time, given that the rise in the unemployment rate has been fueled largely by rapid labor force growth. But this doesn’t invalidate the idea that a tipping point exists, and that the labor market has either crossed or is approaching it.

The Fed doesn’t get to wait for perfect knowledge before acting. It always risks doing too much, or too little. The question is, which is worse? Cutting rates half a point isn’t riskless. Long-term Treasury bond yields are already lower than short-term rates—a relationship called an inverted yield curve—and could fall even further, pulling down mortgage rates. Stocks could turn frothy. That would stimulate spending.

Inflation could also prove stickier or even edge higher, especially if oil rebounds or tariffs are raised. If that happens, the response should be straightforward: Don’t cut again. Rates would still be relatively high.

Cutting only a quarter point looks riskier, though. One reason oil and other commodity prices such as copper have fallen is because the global economy, in particular China and Europe, looks sickly. Mounting auto loan and credit card delinquencies show higher rates are biting. The yield curve is inverted because markets think interest rates ought to be lower.

The Fed has already erred on the side of moving slowly. In hindsight it should have cut in July given the weak employment and generally tame inflation data that followed. If the Fed only cuts a quarter point now and more weak data arrive, it would be even further behind the curve.

...some onlookers are beginning to worry that the Fed might fall behind the curve if it reacts too gradually — something that would leave it scrambling to lower borrowing costs quickly enough to keep the job market from falling to pieces.

“Not all slowdowns lead to recessions, but all recessions start with slowdowns,” said Skanda Amarnath, executive director at Employ America, an employment-focused research and advocacy group. “I think the data is signaling a certain amount of urgency.”

The Fed has been approaching rate cuts cautiously because it does not want to risk taking its foot off the economic brakes too early or too swiftly, allowing the economy to heat back up and making it harder to fully stamp out inflation.

But caution on the inflation front could translate into risk-taking on the employment front...

“It should be clear to everyone that many prepandemic economic relationships have not proven to be good policy guides post-pandemic,” Christopher J. Waller, a Fed governor, said in a recent speech. “While I don’t see the recent data pointing to a recession, I do see some downside risk to employment that I will be watching closely.”

When I hear people say “Well, 50 bps is telling the market that the Fed thinks we have a big problem and could lead to a risk-off tantrum,” my thought is that NOTHING in this steroidal, Frankenstein — cycle has been normal (unprecedented Monetary and Fiscal interventions, Market overshoots & undershoots, with violent turns and regime shifts creating Momentum shocks), as the fact is that we have experienced 11 Fed hikes in a year and a half, including multiple 75 bps blasts . . . so making commensurate — type moves on the policy reversal should kinda be expected, no?!

"And I was on CNBC last week and someone said, well, what's your view on rate cuts. And I made the point that if you are going to cut 75 basis points between now and year-end, you're much better off cutting 50 basis points now because you'll spur more economic activity next year because corporations are making decisions about next year now. And if they know they have 50 basis points on a huge balance sheet of debt, they could do more hiring, they could do more investing even having that information." – SoFi Technologies CEO Anthony Noto

@carlquintanilla: JPMORGAN, on cruise lines: “.. demand backdrop for cruise remains ‘strong’ with ‘zero signs of softening in any lead indicator’ (i.e. booking curve, price or onboard spend). “.. Putting the pieces together .. raising 3Q EPS across the sector with our bottom-up model work pointing to mid-single- digit(+) yield growth in FY25 ..”

@bluff_capital: $RH "We are pleased to report that demand was up 7% in the second quarter and has continued to inflect positive, gaining momentum each month with July finishing up 10%. Demand accelerated into the third quarter with August up 12%."

Citi analysts citing meetings with Walmart management: It sounds like they had a really good back-to-school season, and management is optimistic about H2; They have not seen any “fraying” within their customer base - They are gaining share in both their core customer base as well as with higher income customers, and newer customers are sticking with them (and shopping across categories).- We came away believing WMT’s topline momentum and market share gains continue, most recently highlighted by a strong back to school season.

@KevRGordon: Empire Manufacturing Index 6-month new orders outlook soared to +39.9 in September ... best since March 2022

@tracyalloway: "The golden age of credit"" by the numbers, via BofA:

@ericwallerstein: CPI is now running at 1.2% y/y ex-shelter. Goods prices are deflating hard due to China & -10% y/y gas prices.

@wabuffo: Inflation is now below 2% y-o-y in August if a private sector measure of shelter inflation (ZORI = 3.36%) is used instead of the BLS's measure (5.20%).

@bespokeinvest: There seems to be a race between gas prices and mortgage rates to see which one can go lower lately.

@GunjanJS: One of the largest home-building ETFs, ITB, is up 88% since the Fed's first interest-rate increase in March 2022. Over that time frame, mortgage rates surged from ~3% to 7.8%, touching a two-decade high.

@BobOnMarkets: Are you better off now than four years ago? The Fed just reported that US household net worth rose to a new record as of June 30, to $163.8 TRILLION, up 37.7% from four years earlier. That exceeds the 26% gain between mid-2016 and mid-2020

Mastercard said it would acquire cybersecurity company Recorded Future in a $2.65 billion deal, as intelligence on cyberattacks takes on greater importance amid growing threats from hackers.

The financial services giant said it would incorporate Recorded Future’s technology, including artificial intelligence, into its fraud prevention, identity and cybersecurity services. It expects to close the acquisition by the first quarter of 2025.

Recorded Future, based in Somerville, Mass., is being sold by private-equity firm Insight Partners. It provides threat intelligence to help clients assess cyber and geopolitical risk, and can monitor them for vulnerability to attack from unpatched technology and known hacker tactics.

@SamRo: "According to BofA Global Research analysts, AI may drive margin expansion for 23 of 25 industry groups" - BofA

@TheTranscript_: $ORCL CTO Larry Ellison: "I went to dinner with @elonmusk, Jensen Huang..& I would describe the dinner as Oracle & me & Elon begging Jensen for GPUs. Please take our money....No, no, take more of it. You're not taking out enough. We need you to take more of our money, please"

Like Apple Inc., Nike was masterful at making product breakthroughs and engineering cultural movements along with them. Nike hired Donahoe to transform its selling machinery for the modern age, cutting out middlemen so it could get better margins from each sale. He led a corporate culling on a global scale, ending relationships with more than half of his retail partners, terminating hundreds of agreements and downsizing sales teams in markets around the world. As Nike directed customers to its own stores and websites, it halted the flow of sneakers to retailers including Amazon, Zappos, Dillard’s and Urban Outfitters, and even curtailed goods at its closest partner in the US, Foot Locker.

Donahoe’s strategy seemed to be working, until it didn’t. That recently abandoned shelf space was quickly filled by all of Nike’s top competitors: Adidas, New Balance, Puma, even Ugg. A flurry of running shoe brands, many of them upstarts such as Brooks, Hoka, On and Salomon, suddenly found themselves with more exposure, and they ate away at Nike’s market share in one of its most important categories. Meanwhile, at the company’s headquarters, the pace of product development slowed as Donahoe took fewer risks on performance-oriented shoe lines across sports. By mid-2023, it was becoming apparent that Dunks and the other reliable lifestyle winners were losing their allure, and Nike had nothing to replace them.

In December the company slashed its revenue forecast and Donahoe shifted into Bain mode, admitting on a conference call with analysts that “we know we must be faster, increasing the pace of innovation.” He unveiled a plan to cut $2 billion in costs, which included getting rid of 2% of the workforce. In interviews with more than 50 current and former Nike corporate employees—including many executives and senior managers who spoke on the condition of anonymity because they still work for Nike or elsewhere in the industry and worry about career repercussions—the moves were characterized as sapping their remaining faith in Donahoe’s regime. “He’s lost the community at Nike,” says Travis Gonzolez, Nike’s former director of client relationship and communication, who was laid off by the company in May.