Shifting Odds, High Stakes
“If a merchant should give silver to a trading agent for an investment venture, and he incurs a loss on his journeys, he shall return silver to the merchant in the amount of the capital sum.”
Code of Hammurabi, 1792-1750, BC
THIS IS NOT INVESTING ADVICE. INVESTING IS RISKY AND OFTEN PAINFUL. DO YOUR OWN RESEARCH. If you like these essays and podcasts, subscribe. That’s the cleanest indication you value the work.
Today I want to talk about the timing of now rolled-back Fed cuts, a reality rippling through markets.
The Fed policy choice is about inflation, but it can also help tip the election, one variable among many. This means their choice is a small, but important shift in a larger, higher-stakes political context. If Trump wins, Ukraine loses. If Ukraine loses, Putin wins. Putin will extend his gains, as he is already doing in Moldova and Georgia. The odds of Xi moving on Taiwan go up. The big take-home point will be that no country should be without nuclear weapons, which Ukraine gave up in 1996.1In short, the world will become a more dangerous place very fast.
Source: Real Clear
An earlier cut favors Biden and no cut or a later cut favors Trump. While the Fed knows this, they will never say it out loud and if asked will vociferously claim they are merely technocrats. In general, that is true, not this time.
The Economic Data
Below is the data the Fed and the markets are seeing. With data like this, against a poisonous political backdrop, it seems unlikely they can cut in June. At the beginning of the year, Goldman Sachs and others were anticipating one cut each quarter. Seemed reasonable. Given the new information, bonds are selling off and stocks have stopped rising.
I think the inflation data is a blip. But I don’t know if the data turns fast enough to give the Fed the political cover they need to cut. Here is what informs my thinking:
1. Growth is indeed slowing. Remember these growth numbers are a netting of the parts of the economy in the AI boom and the rest of the economy. I think the non-AI economy is slowing a lot because private sector credit is weak and income, while growing, is slowing.
2. Inflation is slowing too, even if the monthly numbers are choppy. The next read we get on the Fed’s preferred measure of inflation, shown quarterly below, is 3/29. That’s an important data release.
3. Parts of the economy are still playing catch-up after Covid. For instance, the big bumps to employment in the last six months are “health services,” according to the Bureau of Labor Statistics, and restaurant workers. These are groups that saw enormous labor volatility during Covid.
Within the health services (this is getting in the weeds), the big increase is in ambulatory care, which I’m surmising is older people getting transported to operations they had put off and also hourly nurses (expensive) being replaced by full-time staff (less expensive). One way or another, it is post-pandemic noise that will (when?) gradually settle. Other areas of hiring are more tepid, almost flat. Similarly, the biggest contributor to inflation in the last twelve months is transportation costs, as you can see below.
Looking at these reports, I think the market is in the midst of a head-fake. But the data needs to turn for the Fed to do what they say they want to do—cut.
“It looks to me like he’s trying to lower interest rates for the sake of maybe getting people elected, I don’t know,” said Trump, appearing on Fox on February 2, referring to Powell. Imagine that in your head if you are the Fed.
JPM produced a chart, below, analyzing Fed policy around elections. JPM’s conclusion is the Fed indeed has no political bias, they are as likely to cut as to ease around an election.
My take is different.
Keep reading with a 7-day free trial
Subscribe to Things I Didn't Learn in School to keep reading this post and get 7 days of free access to the full post archives.