Confidence Game

By Benjamin Picton, Senior Macro Strategist at Rabobank

As we approach the Jackson Hole Symposium later this week the message from Fed speakers, broadly, has been that they are gaining confidence that the economy is reaching the point where the Fed Funds rate can be cut. Speaking to the Financial Times on Friday, Atlanta Fed President Raphael Bostic said that he is “open” to a Fed cut in September and, critically, that the Fed “can’t afford to be late” in delivering policy easing.

Bostic’s comments reflect the emerging dichotomy between cooling inflation indicators and a labour market that is showing clear signs of softening. PPI and CPI figures for July released last week both surprised on the low side, helping to shift the main focus of concerns away from persistent inflation pressures and towards the labor market where a soft non-farm payrolls report of a fortnight ago sent fear-of-recession shocks through markets.

Markets have become increasingly sensitive to labor market data of late. That is why the last two weeks of initial and continuing jobless claims (usually considered second-tier data) have been key points of interest and generate significant price action upon publication. Those claims numbers printed on the low side again last week, further calming nerves that the jobs market might be heading for a crash rather than the carefully managed “soft landing” that the Fed has been aiming at.

Nevertheless, Bostic reminded us of the hackneyed phrase that monetary policy acts with ‘long and variable lags’ (both on the way up, and on the way down). The intuition here is that central banks need to be adding some lift to the economy before the wheels make contact with the tarmac by easing policy rates ahead of (lagged) data confirming that the economy has actually reached the inflation target.

Bostic’s Fed colleagues Austan Goolsbee and Mary Daly sent similar messages over the weekend on the appropriateness of policy easing. Goolsbee pointed to signals in the labour market and signs of deteriorating credit quality as “various leading indicators of recession”, suggesting that “some of those are giving warning lights”. Goolsbee noted (correctly) that when the unemployment rate starts to rise quickly it is difficult to stop. “It [the unemployment rate] tends to go up like a rocket and down like a feather.”

Mary Daly also plumped for cuts, but was a little more circumspect on the risk of deterioration in the labor market. In comments to the Financial Times, she said that she had “more confidence” on the inflation outlook, and that it was now time to consider a cut to the Fed Funds rate. Daly’s assessment of the labour market seems to be less pessimistic than Goolsbee or Bostic. She said that the labour market is softening, but it is not “weak”, and that gradual loosening of monetary policy would be “prudent”.

So, what are we to make of all of this? Well, a September cut to the Fed Funds rate appears to be all but a done deal. Market attention now turns to the pace of easing, the endpoint of easing, and whether labor market pessimists like Goolsbee and Bostic will successfully push for the first cut to be 50bps rather than the standard 25.

Recall that Fed Chair Powell admonished journalists in early May for suggesting that the economy was experiencing stagflation. “I don’t see the stag, or the ‘flation” was Powell’s comment at the time. Fast forward to last weekend and it seems that Goolsbee and Bostic are picking up distinct ‘stag’ vibes, as is our own US Strategist Philip Marey. Philip has had a September cut pencilled in for ages, primarily because he has been expecting the economy to deteriorate toward recession in the final quarter of the year.

Last week’s solid jobless claims figures, in conjunction with a strong retail sales report and a better-than-expected University of Michigan consumer sentiment reading (that showed households simultaneously less optimistic about the present and more optimistic about the future) has probably lessened the case for the Fed to start the easing cycle with a supersized 50 bp cut. US 2-year bond yields were little changed over the course of last week, but the futures market still has ~33bps worth of cuts priced-in for the September meeting, highlighting that Bostic and Goolsbee are not alone in harbouring latent nervousness that the Fed may have dithered too long in reducing policy restrictiveness in therefore seek to play catch-up.

Jackson Hole aside, there is another important gathering occurring this week: the Democratic National Convention. The Convention kicks off today and will run through to Thursday. Having already secured the Democratic Party’s nomination, the event is likely to be a stage-managed coronation for Kamala Harris and a fresh opportunity for the Harris-Walz ticket to attack their Republican rivals. There may also be further meat added to the bones of the Harris policy platform, which started to take shape last week.

In a speech in North Carolina on Friday Harris outlined key planks of her plan to create an “Opportunity Economy”. A Harris administration will seek to enact a $6000 refundable child tax credit for newborns, build 3 million new homes, provide up to $25,000 for first home buyers, and place a federal ban on price gouging in the food and grocery industry.

Much of this is controversial. First home buyer grants have been tried the world over and many economists will tell you that they are effectively a subsidy for home-sellers as they pump up demand in supply-constrained markets. Just ask an Australian millennial or Gen Z’er where those sorts of populist demand-side policies ultimately lead a housing market.

The loudest criticism of the Harris platform (including from traditionally Democrat-friendly outlets like CNN and the Washington Post) has been reserved for the ban on price gouging. Republicans and some media outlets have likened the ban to federally imposed price controls (a-la Richard Nixon) that can ultimately lead to shortages and further inflation when the controls are eventually removed. Curiously, gold hit new all-time highs of more than $2,500/oz ahead of Harris’ speech and following news that the ban on price gouging would be announced.

Since Joe Biden announced that he would not be seeking re-election, and Harris quickly moved to solidify her position as the presumptive Democratic nominee, Donald Trump’s polling lead has evaporated, and Harris now leads in many national surveys and key swing states.

The economy has long been a weak spot for the Biden/Harris administration, and the media reaction to Harris’ first major economic policy announcement seems to suggest it could be the first major miss-step of her campaign.

That will give Donald Trump confidence that he is still in the game.