This week’s FOMC decision was not an easy choice. Our goals are in conflict. Inflation is above target, the labor market is softening, and there are risks to both sides of our mandate—maximum employment and price stability.
Two charts explain why I ultimately favored a rate cut.
The first shows the damaging cost of high inflation. It has chipped away at real earnings and weakened household purchasing power. Many Americans are still trying to catch up.
So, the FOMC must continue to bring inflation down. Anything other than 2% is not an option. But it matters how you get there. This means we cannot let the labor market falter.
Real wage gains come from long and durable expansions. And the current expansion is still relatively young, as shown in the second chart. Holding policy too tight can cause undue harm to American families and leave them with two problems: above-target inflation and a weak labor market.
Congress gave us two goals. And our job is to meet both of them. The recent policy decision puts us in a good place to achieve that.
…It has begun. Over the last year, I have made the strongest possible case for the Fed to be proactive. Rates should have been cut this week – indeed, the rates should have been cut in January.
We have seen this movie before. The Fed was very late to take inflation seriously in 2021. They brushed it off as “transitory”. However, it seemed obvious that inflation was surging. Real-time shelter inflation was increasing at a double-digit rate. Shelter has the largest weight in the CPI. Shelter operates with a lag. Hence, it was easy to forecast the surge. The Fed was forced to react after the damage was done.
The same mistake has been repeated – despite many warnings. The recent CPI print was 3% year-over-year (YOY). Nearly two thirds of this print was driven by one component – shelter. Shelter inflation is reported at 5.2% YOY. This number is far from reality. For example, Apartmentlist.com rents are running -0.8% YOY - a full 6% below the official CPI number. Suppose we believe the real-time shelter inflation is 2%, not 5.2%. This means the real-time CPI would be 1.8%. If you believe shelter is 3%, then real-time CPI would be 2.2%. These numbers are well within the Fed’s target.
The Fed prides itself on making data-driven decisions. However, it is unwise to make decisions based on stale data. The shelter inflation happened in the past. Keeping rates high will not impact what happened last year.
It is always best to look at forward-looking indicators for policy decisions.
· My yield curve indicator has been inverted for 20 months. It is 8 of 8 with no false signals since the 1960s. The maximum historic lead time has been 23 months (before the great recession). Ignore it at your own risk.
· The Sahm Rule has been triggered. This indicator is not necessarily predictive because employment moves with the business cycle – but it is useful in telling us whether we are in a recession or not. We know that hiring has slowed and unemployment has risen – though the absolute rate is still relatively low.
· Retail sales are highly correlated with personal consumption expenditures. Retail Sales are flat. Many do not realize that Retail Sales are not inflation adjusted. Taking inflation into account recent sales growth as well as YOY sales are negative.
· There is considerable evidence that COVID-era savings have been drawn down. A recent release from Philadelphia Fed carried the headline: “Share of Delinquent Credit Card Balances Reaches Series High”. (The same report shows an alarming plunge in mortgage originations.) People are paying 20%+ interest on a card because their savings have run out. Indeed, if people are cutting back on fast-food expenditures, you know this is serious. Drawing down the savings has fueled consumption expenditures over the past two years. That source of growth has ended.
Now the Fed will have to play catch-up and cut by at least 50bp in September.
Any recession is a self-inflicted wound.
• We reduce our S&P 500 3-month and 12-month return forecasts to -5% and +6% (previously +0% and +16%). Based on market prices at the end of last week, these suggest S&P 500 index levels of roughly 5300 and 5900, respectively.
• Higher tariffs, weaker economic growth, and greater inflation than we previously assumed lead us to cut our S&P 500 EPS growth forecasts to +3% in 2025 (from +7%) and +6% in 2026 (from +7%). Our new EPS estimates are $253 and $269, respectively. These estimates are below both the top-down strategist consensus and the bottom-up consensus of equity analysts.
• Slowing growth and rising uncertainty warrant a higher equity risk premium and lower valuation multiples for equities. The S&P 500 entered 2025 trading at a 21.5x P/E multiple on consensus forward EPS, and currently trades at a multiple of 20x. With little change to consensus EPS estimates, all of the 9% sell-off from the market peak in February has stemmed from valuation contraction. We expect a further valuation decline in the near-term, with the P/E registering 19x in 3 months and rising modestly to 19.5x in 12 months.
• Our economists estimate a 35% probability that the US economy enters a recession during the next 12 months. The historical equity market recession playbook implies a roughly 25% S&P 500 drawdown from the recent market peak. If followed, this pattern would suggest a further 17% drawdown from today’s price to a trough level of roughly 4600. This would represent a P/E multiple of 17x current consensus forward 12-month EPS. During the last three major S&P 500 downturns, the P/E multiple bottomed at 15x (2022), 13x (2020), and 14x (2018).
• We continue to recommend investors watch for an improvement in the growth outlook, more asymmetry in market pricing, or depressed positioning before trying to trade a market bottom. Although our Sentiment Indicator has declined sharply during the last few weeks (to -1.2), it remains above levels reached at the troughs of other major sell-offs during recent years (-2.0 or lower).
• Within the market, we recommend our Stable Growth basket (ticker: GSTHSTGR), which contains the stocks with the least variable earnings growth during the past decade, and our Insensitive Portfolio of stocks with minimal correlation to the major thematic drivers of recent equity market volatility.
The Reserve Bank of India has released a Discussion Paper (DP) on the Review of the Monetary Policy Framework. The current inflation target under the flexible inflation targeting (FIT) regime is due for review in March 2026. The DP poses the following questions for feedback:
1. Whether headline inflation or core inflation would best guide the conduct of monetary policy, given evolving relative dynamics of food and core inflation and the continuing high weight of food in the CPI basket?
2. Whether the 4 per cent inflation target continues to remain optimal for balancing growth with stability in a fast growing, large emerging economy like India?
3. Should the tolerance band around the target be revised in any way including whether the tolerance band be narrowed or widened or fully done away with?
4. Should the target inflation level be removed, and only a range be maintained within the overall ambit of maintaining flexibility without undermining credibility?
RBI is inviting comments from stakeholders and the public by September 18, 2025.
https://lnkd.in/gFnPjP8y
“Water water everywhere, nor any drop to drink.”
I first heard The Rime of the Ancient Mariner recited by a famous actor while in grade school. That image came to mind as I thought about the deluge of data we are about to get. It will fall short of quenching our thirst for information on the economy, and is adding to the argument to pause on rate cuts by the Federal Reserve.
The October CPI cannot be backfilled due to a loss in survey information. The same goes for the Household survey, which is used to calculate the unemployment rate, and is chock-full of data on how well the labor market is performing for all kinds of workers.
The November surveys will be done late and could have holes. We were already imputing 40% of the CPI in September due to staffing shortages at the Bureau of Labor Statistics; many field offices that collected data have closed.
The Fed is left with a dueling instead of a dual mandate and a scarcity of new data to give clarity on the direction of inflation and the labor market. Chairman Jay Powell warned that a December cut was “not a foregone conclusion” for this very reason. The warning followed a contentious October cut.
The CPI for September came out cooler than feared. But price hikes became more dispersed, showing up outside of areas affected by tariffs in the service sector.
Making matters more complicated are record tax refunds, which will hit in ealry 2026. That is a double-edged sword as we saw during the pandemic. Fiscal stimulus cushions the blow of higher prices, while fueling inflation. Proposed rebates on tariffs would increase those risks, while adding to deficits.
We cannot sustain full employment without price stability. Any short-term gains in employment due to rate cuts could be quickly wiped out by resurgent inflation.
Further muddying the waters is whether the weakness in the labor market going forward is structural - due to aging demographics, curbs on immigration and innovation - or cyclical. Structural losses are harder to reverse via rate cuts.
Financial conditions for large companies, which are announcing major layoffs, remain extremely easy. That means additional rate cuts run the risk of stoking more inflation instead of employment.
Inflation is corrosive and hits 100% of the population, while unemployment hits only a few percent of the population. Both are bad - they are worse together.
We have not had to deal with both since the 1970s. The Fed mistakenly cut too much back then, which is informing their decisions today.
The Rime of the Ancient Mariner is a story of redemption and penance. The Fed’s reputation on inflation needs redeeming. The penance is slower cuts in rates than most would like. A pause in December is likely. The trajectory of rate cuts thereafter will depend on more complete data on the economy and shifts in Fed leadership.
Moral of the story: A loss of data leaves us thirsting for more and has left the Fed with no risk-free policy choices.
Fed Holds Rates Steady, Signals Two Cuts This Year—But Uncertainty Looms
The Federal Reserve kept interest rates unchanged, with its closely watched dot plot now implying a median of two rate cuts by year-end. At first glance, that may sound dovish. But a closer look at the details suggests a more cautious tone beneath the surface.
Compared to March, more Fed officials are now penciling in fewer rate cuts, indicating growing divergence within the committee. Meanwhile, the Summary of Economic Projections reveals upward revisions to both inflation and unemployment forecasts—largely due to the impact of tariffs. That shift points to a more hawkish tilt, not a more accommodative one.
Adding to the uncertainty, the recent spike in oil prices—driven by geopolitical tensions—is clouding the inflation outlook and complicating the Fed’s policy path.
While the Fed’s projections offer insight into its current thinking, their usefulness has diminished in a trade environment shaped by tariffs at levels not seen in decades. Combined with a still-evolving post-pandemic economy, these dynamics make a near-term pivot unlikely until there is more clarity on both trade policy and inflation trends.
While it is loads of fun to think all is well, we must on occasion confront our biases regularly in order to survive long-term. So allow me to help with that. Fed Funds is at 5.50%; 30-fixed mortgage rates are at 8%; CRE re-fi's are pushing 9%+ and losses are accumulating. Over $8 trillion of US debt will re-fi from a ~2% coupon to a ~5% coupon in the next 12 months. Inflation from the beginning of the Biden presidency in January 2021 to now is nearly 18%.
And now one more brick in the wall folks. The US Leading Economic Indicators (LEI) Index has dropped again for the 19th consecutive month. That is the longest streak of consecutive monthly LEI index declines since June 2007-April 2008 (22 months).
There are 10 components of the LEI Index: Average weekly hours in manufacturing; Average weekly initial claims for unemployment insurance; Manufacturers��� new orders for consumer goods and materials; ISM Index of New Orders; Manufacturers’ new orders for non-defense capital goods excluding aircraft orders; Building permits for new private housing units; S&P 500 Stock Price Index; Leading Credit Index; Interest rate spread (10-year Treasury bonds less federal funds rate); Average consumer expectations for business conditions.
The LEI Index, an index of indexes, is "... constructed to summarize and reveal common turning points in the economy in a clearer and more convincing manner than any individual component," per the Conference Board, which publishes the index. As part of the latest report, they said "The Conference Board expects elevated inflation, high interest rates, and contracting consumer spending - due to depleting pandemic saving and mandatory student loan repayments - to tip the US economy into a very short recession." They expect a short recession in 2024 and a very low positive GDP of +0.8% for the year.
The Conference Board's recession call is a revision from their report last month, where they expected a soft landing. Just saying... Expect the best; prepare for the worst.
#fedpolicy#interestrates#riskmanagement
Today’s Beige Book (link below) highlights the policy challenge facing this highly data-dependent Federal Reserve.
On one hand, the latest surveys from the regional Feds point to firms reducing employment through attrition and firings. This aligns with Chair Powell’s remarks yesterday, suggesting a softening labor market that could justify further rate cuts.
On the other hand, the Beige Book complicates the policy conclusions in two ways.
First, it reports that input costs are rising at a faster pace than before in many districts, even as consumer prices continue to climb.
Second, it suggests that both supply and demand factors, and not just the latter, are driving the weaker jobs picture.
Bottom line: The backward-looking numbers that this Fed has been using and citing as its main policy influencer do not give a green light for more rate cuts. Instead, what has been a highly data-dependent Fed needs to also apply a forward-looking, strategic judgment—something it has been reluctant to do since its major (“transitory” inflation) policy mistake in 2021.
https://lnkd.in/eBeATHRj#economy#federalreserve#markets#inflation#jobs#employment
Why Has the Fed Cut Interest Rates by 0.5% While the Bank of England Held Steady?
The recent decision by the Federal Reserve to cut interest rates by 0.5% while the Bank of England has chosen to keep rates unchanged highlights a key difference in how these central banks approach their economic responsibilities. Although both are tasked with maintaining financial stability, their mandates and priorities diverge, leading to different strategies in response to similar economic conditions.
The BoE’s primary mandate is to manage inflation, thereby ensuring price stability by keeping inflation around its 2% target. In recent times, the UK has experienced inflationary pressures, partly driven by supply chain disruptions, rising energy prices, and other global factors. By the BoE holding rates steady, they signall that controlling inflation is more important than short-term economic growth. This conservative stance reflects the view that failing to address high inflation could lead to greater economic instability in the long run.
In the BoE’s framework, the priority is clear: inflation management comes first, and the focus is on preventing inflation from spiralling out of control. Growth is a secondary consideration. Therefore, even if growth slows down or there are concerns about a potential economic downturn, the BoE’s stance remains firmly centred on inflation control, as persistent inflation can erode purchasing power and destabilise the broader economy. A cut in interest rates would risk fuelling inflation further, which the BoE sees as too high a cost to bear at present.
On the other hand, the Fed operates under a dual mandate. This means the Fed must balance two equally important objectives: keeping inflation stable while also promoting maximum employment and economic growth. With this dual mandate, the Fed has a more flexible approach, as it is required to support economic activity while keeping an eye on inflation. In the current environment, the Fed has seen signs that US economic growth is weakening—whether due to slowing demand, challenges in the labour market, or external global pressures. Although inflation remains a concern, the Fed judged that an interest rate cut was necessary to prevent a significant economic slowdown.
By cutting rates, the Fed aims to encourage borrowing, investment, and spending, which can help stimulate economic growth and support employment levels. This decision reflects the Fed’s broader remit to foster conditions that promote both stable prices and robust economic activity. The 0.5% rate cut, therefore, is not just a reaction to inflation but also a pre-emptive measure to avoid a potential recession or economic stagnation.
Therefore, the difference in response is likely due to diverging mandates. The BoE, focused almost entirely on controlling inflation, therefore keeps rates steady to prevent further inflation. But, the Fed is balancing inflation concerns and economic growth/employment, so cuts rates.
Navigating the Federal Reserve’s Tightrope: A Delicate Balancing Act or an Imminent Misstep?
Arguments can be made that we have observed the Federal Reserve's skillful navigation through economic uncertainties, notably during the challenging times of the COVID-19 pandemic. Initially criticized for maintaining loose monetary policy, the Fed's actions successfully averted a deflationary bust. However, recent developments raise a critical question: Is the Fed sleepwalking into a policy error?
The Federal Reserve's recent hawkish tilt has stirred concerns among market participants, notably evident in the pronounced bear steepening of the yield curve. The surge in both the 2/10 and 5/30 yield curves signals a tightening of U.S. financial conditions, impacting long-term investments like mortgages and corporate debt. These rate increases pose potential challenges to economic stability.
The current economic landscape is characterized by unprecedented uncertainty regarding the trajectory of U.S. GDP. Divergent growth projections, ranging from the optimistic 4.9% by the Atlanta Fed to the more conservative estimates by the NY Fed and private forecasters, contribute to this ambiguity. This uncertainty is compounded by a rapid decline in U.S. nominal GDP growth rates, a trend inconsistent with projected policy rates.
Persistent inflationary concerns persist despite external factors beyond the Fed's control, such as shutdowns, strikes, and energy prices. The crucial question arises: Is the recent hawkish tilt a premature response that could jeopardize the delicate balance achieved in the past three years?
The Fed's current outlook of a 'soft landing,' implicit in its latest projections, appears incongruent with the recent hawkish tilt. This dissonance leaves investors pondering the possibility of a more challenging economic landing or a swift Fed pivot. Considering the Fed's historical reluctance to tighten and the evolving economic landscape, a pivot seems increasingly likely.
Upon closer examination, it becomes evident that the Fed may have already made critical missteps. The belief in the 'Fed Put' as an omnipotent safety net led to market complacency. Downplaying the persistence of inflation created an environment where businesses and investors acted as if inflation was transitory. Now, the question shifts from the potential for a policy mistake to whether the Fed can effectively rectify these prior errors.
The tools at the Fed's disposal are blunt, and historical performance suggests caution is warranted. Sophisticated investors must stay vigilant as the Fed's communication strategy will play a pivotal role in guiding market expectations. A potential pivot in communication, followed by liquidity adjustments and interest rate changes, could be on the horizon. Navigating these complexities requires flexibility and a keen awareness of the evolving economic landscape, essential for weathering potential storms on the horizon.
What do you think?