“Confidence is a preference…“
Blur, Parklife
In our last piece, we discussed the evolution of activity in the real economy, both in the UK following the most recent (arguably dovish) MPC meeting and, more importantly, in the US. We emphasised the statement of the Bank of England that "the restrictive stance of monetary policy is weighing on activity in the real economy, is leading to a looser labour market and is bearing down on inflationary pressures". A statement we would argue applies to the US just as much as the UK. Essentially, we (re)emphasised our view that we see the consumer as weaker than the headline data has suggested in the UK but most notably in the US. Recent data, however, appears to be converging lower, and there are clearer signs of growth moderation and supply normalisation (goods and labour).
Employment revised
Last week, we referenced a California legislature (LAO) report highlighting a significant downward revision to job creation in the state of California in Q4 2023, giving a very different perspective to the state of the US labour market. (The report discussed recent revisions to data that initially saw job growth of 117,000 in the 4th quarter of 2023 and now shows a decline of 32,000). Since then, we have had the US employment report for June.
The June NFP report saw payrolls rise 206,000 in the month - higher than expected. However, the composition of the report was significantly weaker. Firstly, there was a significant downward revision to the previous two months, taking the 3m average to 177k (from 249k prior to those revisions). Secondly, the sector breakdown of the jobs report showed three-quarters of the job gains were in government and healthcare - with several sectors shedding jobs (retail, manufacturing and temporary roles). Lastly, a weak household survey pushed the unemployment rate up to 4.1%, with a continuation of the decline in average hourly earnings to 3.9% y/y. Overall, the data infers that the labour market is weakening.
Nonlinearities and Monetary Policy
We have argued in many pieces that the Fed monetary policy reaction function, in its most recent iteration, is most acutely sensitive to changes in the labour market against the current, well-behaved inflation path. Indeed, there have been a number of Fed comments lately that lead us to think that this 'sensitivity' has even increased. Fed board member Lisa Cook, in a speech in Australia this week, stated that the Fed is "very attentive" to changes in unemployment and that "nonlinearities" are a risk in a job market slowdown - a reference to the potential change in shape or slope of the US Beveridge curve now that the jobs gap has likely closed (inferring a greater sensitivity of the unemployment rate to a further slowing of demand).
Perhaps more pertinently, Powell's Q&A at Sintra and testimony to Congress this week also gave a more dovish interpretation of the current US macro backdrop than the most recent Fed (and indeed the most recent 'dots'). In testimony this week, Powell stated that the Labour market has cooled "pretty significantly" and notably that "inflation is not the only risk we face".
Growth Confidence
If we consider the slowing in consumption metrics in the US that have been more apparent in the recent data and the potential business investment (hiring) uncertainty in the build-up to the US Presidential election in November - not to mention the recent market and Fed speaker focus on the forward sensitivity to slowing demand - remain indicative of a continuing moderation in consumer demand. This should further concentrate the markets' focus on the US growth trajectory and policy implications. With US rates well into restrictive territory and with signs of weakness emerging in the labour market and at the consumer level, we think that the Fed can bring forward rate cuts significantly in the US - not just through 2024 but also into 2025.
Inflation Confidence
This week's inflation report was also very important. From our perspective, the illusive 'confidence' that the Fed have been seeking to enact rate cuts from the current restrictive policy setting is a function of base effects. If the m/m inflation data prints at 0.2% for the rest of 2024, then the y/y rate likely remains unchanged at year-end. This is consistent with the Fed forecasts (June SEP's) and, in our view, with two rate cuts in 2024. However, if those monthly prints were to come in at 0.3% m/m for the rest of the year, the annual comparison would climb to close to 4% (an uncomfortable inflation level for the Fed). The fact that this week's data print surprised markets to the downside at 0.1% m/m is thus significant in this context…
At the component level, it was rents that finally saw a significant correction (down to pre-pandemic levels) - another essential component for Fed' confidence' on the path of inflation to target. Despite the fact that some of the weakest components of the CPI report have a smaller weighting (and thus less impact) in the PCE, it was clearly a dovish iteration. Indeed, combined with the fact that there was a clearer weakness in the discretionary elements of the CPI print the developments continue to warn of further growth moderation.
The Long and Short of it
Last time we wrote, we posed the question, 'are rate cuts just around the corner?' If that is the case, then this week may constitute the apex. Indeed, if we combine the further good news on the inflation front with the significant cooling of the labour market then it is likely the Fed have taken a significant step on the path to 'sufficient confidence'. Ultimately, from our perspective there has been a significant evolution in the US macro backdrop - evolving more clearly towards our long-held disinflation and growth moderation thesis. And, as far as the Fed is concerned from here, to quote Blur, confidence is a preference.
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