Promised Land

It was quiet, too quiet. The lead up to this week’s Fed interest rate announcement was downright boring. After months and months of agita every time the Fed got together to talk about interest rates, this time there was little doubt about what would happen or what the Fed would say. The assumption was that we have reached the terminal rate (i.e., the last rate increase). But have we reached the Promised Land of tame inflation and no recession? Chair Powell wasn’t saying yet. Here is what he did say:

Comments Supportive of This Being the Last Rate Increase:

• • The Committee is no longer forecasting a recession (although they are forecasting a ‘meaningful slowdown’ later this year.)
  • The consumer has slowed
  • Higher rates and slower output growth is weighing on fixed investment
  • Inflation expectations remain well anchored
  • The economy faces headwinds from tighter credit conditions

But he also said this:

Comments Supportive of More Rate Increases to Come:

• • The labor market remains very tight; labor demand ‘substantially exceeds’ the supply of available workers
  • The pace of job growth has slowed, but is still at a strong pace
  • Housing is up, albeit, well below levels of a year ago
  • Economy is growing at a ‘moderate pace’ (last meeting, the term used was ‘modest pace’)
  • Getting to the 2% inflation target ‘likely requires below trend growth and softening of labor market conditions’
  • Inflation has moderated somewhat but we are ‘well above’ the 2% goal and there is ‘a long way to go’ to get to 2%.
  • On balance, the Committee projects that there is another rate hike coming

Immediately after the Powell’s news conference the market did precisely… nothing. By all appearances, the markets got what they expected and had discounted that in advance. Thursday morning, all that changed as stock index futures soared with the S&P 500 up 0.75% and Nasdaq up 1.35% in premarket trading.

At 8:30 on Thursday, we got initial jobless claims and continuing jobless claims, which both declined and were below expectations. At the same time, we also got a preliminary Q2 GDP growth estimate, which was higher than expected. One might think that in light of stronger than expected economic growth and Powell’s comments regarding the labor market the afternoon before, that the stock market would become a bit more hesitant to rally. If you did, you thought wrong. The market appears to have nearly full faith that we have reached the terminal rate and we are entering the Promised Land.

Call us crazy, but here is how we see it. We think Chair Powell made it fairly clear that the odds are good of at least one additional rate increase. The next Fed decision is in September and there will be plenty of new information in the interim period for the Fed to analyze. Powell emphasized that the Committee will be ‘data dependent’, and while some make a big deal out of that, the Fed is always data dependent. This group does not make seat of the pants decisions. That means that inflation and jobs data over the next two months holds the keys to the next Fed decision.

We will make one observation that we believe is important and it is based on these facts:

• Powell repeatedly said that the labor market was tight, there were more job openings then there were unemployed, and that a softening of the labor market was a ‘requirement’ to getting inflation under control.
• We can be 99.9% sure that the Committee already knew the unemployment claims and GDP data during their Wednesday meeting.

We believe that the Fed, while unwilling to commit to another rate hike at this time, was clearly attempting to put a September rate hike on the table. While that strategy appeared to work on Wednesday as the stock market was unusually stable for a ‘Fed Day’, that was blown out of the water by the market rally on Thursday morning and into Friday. The odds of a recession may have come down and the Promised Land may be in sight, but it is far too early to declare victory. The risk now may me moving to a ‘no landing’ (i.e. continued economic growth) scenario, which would likely trigger more rate increases down the road.

Chair Powell’s base case is, and has always been, a soft landing (i.e., a growth slowdown that removes excess inflationary pressure, but does not lead to recession). If he is to be correct, the economy can’t grow too slow, or too fast.

“Swing low sweet chariot, come down easy, taxi to the terminal zone

Cut your engines and cool your wings and let me make it to the telephone

Los Angeles, give me Norfolk, Virginia, Tidewater four-ten-o-nine

Tell the folks back home this is the promised land callin’ and the poor boy’s on the line”

Promised Land, by Chuck Berry

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By: thinkhouse