The Fed just turned dovish even though inflation is running over 2.2%. Yet, there are glaring signs that the US economy is starting to slow. Is this another policy error or a blessing in disguise?
I'm in the camp that we get one rate cut this year, two max, as long as we don't experience some black swan crisis. Great read, really like your Macroeconomic Scenario Map!
Thank you, glad you enjoyed it. I too, don't believe we will get as many rate cuts as the market is pricing in. I think the tapering of QT will do its work on the yield curve, which will most likely also support a strong US economy at the same time. My only worry, is if this turns out to be much accommodation and an inflation spike once again.
I think wage growth and inflation have a nuanced relationship. If real growing wages don't result in growing capex and productivity growth, then it will lead to higher inflation. I think the hardest part of the Fed's job is to drive inflation back to its 2% target, especially when government deficit is so high, while making sure it doesn't tighten too much to induce an unnecessary recession in the economy.
I think they would have better chances of doing so if
a) it did no speculate about future policy instruments.
b) It was prepared reverse course (and re reverse as necessary) to be "data driven." Bumping EFFR up by 25 bp in April might have been a good idea if it ha shaved of 25-50 bp in December/January,
You are not missing anything and your logic is correct. The idea behind why wages may not always contribute to inflation, is that as wages grow and demand rises, producers/companies have the incentive to invest in capex to increase capacity to meet the excess demand, think technology innovation/automation, etc. This increases the overall productivity in the economy and keeps prices more or less anchored.
got it !! the supply side reacts to increase in demand (which is connected to EFFR and interest rates) - but totally !! thank you for your response again, I very much appreciate your time. with increase in demand, higher marginal cost producers can enter the market too - close to market clearing price (equilibrium)
I argue from the first time that markets will continue to be positive throughout 2024 (presidential year moreover), but that a breather in the short-term is necessary and desirable to recharge batteries. Usually in presidential years the deepest sighing months are May, September and October. At the moment SPX doesn't seem to want to hear us, but in the meantime economy is struggling. We shall see what fate awaits us, in the meantime I thank you for this excellent and comprehensive scenario analysis, Amrita!
Thanks Mirko. I agree with you, I think short term, it would be great to get rid of some bloat from the market, as the rally in the first three/four months was based off of overly optimistic scenarios. But the liquidity support does favor at least another rally for the S&P 500 in my opinion, which to your point, hopefully takes place in 2024.
Thank you Amrita for another good article written with care.
Almost everyone I talk to says that they are staying home more and dining out less because of inflation. It is so expensive to eat out now it's ridiculous.
The wealthy just shrug off higher prices, makes no difference to them.
I fully agree with you. Over the last 3 years or so, we have seriously cut back spending dining out when the prices on the menu just kept creeping up every few months. It definitely feels like a different world compared to the ZIRP era, where we would not think much before placing an order on grubhub or doordash every so often.
Comprehensive summary of the macro conditions right now! The market currently looks pretty overvalued on face, however, when you think about that most of the rally was driven by mega caps. There are still ample opportunities on the value side, like UnitedHealthcare. Further, due to the consumer pull-back, discretionary and staples are also becoming attractive. Starbucks is extremely attractive for the long term at this price level.
Fully agree about the selected opportunities in the market, instead of playing the crowded Mag 7 trade. I personally like UNH and CI a lot, own CI. Also, think some of the energy stocks like XOM are well positioned too long term. As for SBUX, I think the deep correction may have created an opportunity, although I have not looked at the fundamentals or the latest earnings report in great detail. What discretionary stocks are you looking at other than SBUX?
There indeed is an opportunity in SBUX. Even the most conservatice assumptions give us $90 price target. I also think MCD and NKE are the other discretionary stocks I closely follow now. For MCD dollar cost averaging starting from now looks like a good strategy, for Nike, I am still concerned about the competition. I have to eliminate that concern before I pull the trigger.
Amrita, can you please tell me more about - how liquidity increase leads to investors investing in riskier assets ? they can just as easily invest in bonds, yeah ? curious on why ?
It is about the equity risk premium. When the yields on risk-free USTs are strong, like they are today, investors actually have an alternative to equities. In fact, many investors will choose to buy Treasuries and T-bills instead, because the added risk premium of equities (not risk-free) is just not worth it. On the other hand, when liquidity is strong, and the yields on bonds go down (could be driven by QE), there is no incentive for investors to buy bonds at such low yields. With expanding money supply, they bid up the prices of riskier assets, such as equities to lock in higher gains than what an yield on the government bond will provide. Hope that answered your question.
got it - I deeply appreciate your time in responding. given weaker economic conditions, which leads to more investing in bonds, which leads to lower bond yield, which leads to investing in riskier assets - to chase yield !
The Federal Reserve has a tough job. They have to make hard, sometimes very unpopular, decisions.
Everyone wants low interest rates today, but most fail to see the long-term consequences.
We must pray that Trump doesn’t win the next election and turn the Federal Reserve into his puppet, as some media sources suggest he intends to do.
As I discussed here: lianeon.org/p/imagining-our-martian-gov…, there is a body of evidence that establishes that the more politically independent a central bank is, the lower inflation and the higher employment will be.
We need technocratic administration, not politician-driven sugar-highs.
Thanks J.K. Couldn't agree more that the Fed has indeed a tough job. On your point about central bank independence, I think the ethos starts to get muddied up, when a nation keeps on growing its deficits larger and wider, or as Stanley Druckenmiller says, "spending like a drunken sailor" and the Fed really has no other choice but to monetize the debt and keep interests low in order to stop government debts from further ballooning. Unless there is some serious measures of austerity taken with government deficit spending, I actually think that the Fed will become more and more politicized regardless of administration.
Thank you great question I asked that to Schwab yesterday the Denver office and I had trouble understanding what the risks of cash to pattern day trading are I only trade maybe 20 times a day max but with the economy and bitcoin on the rise I’ve been just doing pull five put in 5-30 I h have 300 in and have made 50 bucks my first three weeks
Thanks Charlotte. I think more than me, the Fed needs a crystal ball now more than ever. But, sure, I can use one. Imagine I predict all the right outcomes for the economy and the stock market. I will have my own show on CNBC, and my tower in NYC. Oh no, I am getting greedy. Back to work.
The US economy is resilient. The indexes have recently hit new all-time highs, which is a good sign. Technical analysis says they've completed their bottoms. However, I admit that the gains were a little too excessive. The indexes (and most stocks) need to settle into an intermediate- to long-term trading range to pattern out those gains. That's what seem to be happening right now.
If in doubt, use stop losses at strong support levels :)
I'm in the camp that we get one rate cut this year, two max, as long as we don't experience some black swan crisis. Great read, really like your Macroeconomic Scenario Map!
This is where I am at too.
👍🏼
Thank you, glad you enjoyed it. I too, don't believe we will get as many rate cuts as the market is pricing in. I think the tapering of QT will do its work on the yield curve, which will most likely also support a strong US economy at the same time. My only worry, is if this turns out to be much accommodation and an inflation spike once again.
Why does the fed openly strive for lower wage growth? Wage growth does not cause inflation
I think wage growth and inflation have a nuanced relationship. If real growing wages don't result in growing capex and productivity growth, then it will lead to higher inflation. I think the hardest part of the Fed's job is to drive inflation back to its 2% target, especially when government deficit is so high, while making sure it doesn't tighten too much to induce an unnecessary recession in the economy.
I think they would have better chances of doing so if
a) it did no speculate about future policy instruments.
b) It was prepared reverse course (and re reverse as necessary) to be "data driven." Bumping EFFR up by 25 bp in April might have been a good idea if it ha shaved of 25-50 bp in December/January,
wage price inflation, is a thing isnt it ? i pay you more, you demand more things, demand exceeds supply and inflation rises ? what am I missing ?
You are not missing anything and your logic is correct. The idea behind why wages may not always contribute to inflation, is that as wages grow and demand rises, producers/companies have the incentive to invest in capex to increase capacity to meet the excess demand, think technology innovation/automation, etc. This increases the overall productivity in the economy and keeps prices more or less anchored.
got it !! the supply side reacts to increase in demand (which is connected to EFFR and interest rates) - but totally !! thank you for your response again, I very much appreciate your time. with increase in demand, higher marginal cost producers can enter the market too - close to market clearing price (equilibrium)
But since wages are never 100% the cost of production, how could wage increases lead to inflation faster than the wage increases?
Excellent, comprehensive post - the best reading on the market and economy I’ve found in recent weeks. Thanks much.
Thank you Kelly, it means a lot coming from you. Appreciate your support.
Nice summary
Reminds me of Dickens Tale of Two Cities
Ed Yardeni to paraphrase argues we have two economies the rich consumers one and the not rich struggling one
So kind of 1 percent and 99 or maybe 1 percent, 10 percent and the rest
Lots of old baby boomers flush with money and others struggling to make rent
Since the fed always supports assets ie stocks bonds and real estate ie the 10 percent
Let’s see if that keeps holding
After all is that congress the senate and the rich
Even Elizabeth Warren said she is capitalist to the bone and Bernie has three houses last I heard
So “asset inflation” and stagnation
You are spot on with the "tale of two cities" analogy.
I argue from the first time that markets will continue to be positive throughout 2024 (presidential year moreover), but that a breather in the short-term is necessary and desirable to recharge batteries. Usually in presidential years the deepest sighing months are May, September and October. At the moment SPX doesn't seem to want to hear us, but in the meantime economy is struggling. We shall see what fate awaits us, in the meantime I thank you for this excellent and comprehensive scenario analysis, Amrita!
Thanks Mirko. I agree with you, I think short term, it would be great to get rid of some bloat from the market, as the rally in the first three/four months was based off of overly optimistic scenarios. But the liquidity support does favor at least another rally for the S&P 500 in my opinion, which to your point, hopefully takes place in 2024.
Thank you Amrita for another good article written with care.
Almost everyone I talk to says that they are staying home more and dining out less because of inflation. It is so expensive to eat out now it's ridiculous.
The wealthy just shrug off higher prices, makes no difference to them.
I fully agree with you. Over the last 3 years or so, we have seriously cut back spending dining out when the prices on the menu just kept creeping up every few months. It definitely feels like a different world compared to the ZIRP era, where we would not think much before placing an order on grubhub or doordash every so often.
The economy is so overheated that no one can afford to buy anything. :)
Paying any attention to financial markets per se is a mistake. BECASUE the Treasury has not yet created a nominal GDP security,
https://thomaslhutcheson.substack.com/p/improvements-in-macroeconomic-data
the Fed need to look at financial markets to help figure out what it needs to do to restore/maintain inflation at its target rate.
TIPS traders think the Fed will do the right thing.
Comprehensive summary of the macro conditions right now! The market currently looks pretty overvalued on face, however, when you think about that most of the rally was driven by mega caps. There are still ample opportunities on the value side, like UnitedHealthcare. Further, due to the consumer pull-back, discretionary and staples are also becoming attractive. Starbucks is extremely attractive for the long term at this price level.
Fully agree about the selected opportunities in the market, instead of playing the crowded Mag 7 trade. I personally like UNH and CI a lot, own CI. Also, think some of the energy stocks like XOM are well positioned too long term. As for SBUX, I think the deep correction may have created an opportunity, although I have not looked at the fundamentals or the latest earnings report in great detail. What discretionary stocks are you looking at other than SBUX?
There indeed is an opportunity in SBUX. Even the most conservatice assumptions give us $90 price target. I also think MCD and NKE are the other discretionary stocks I closely follow now. For MCD dollar cost averaging starting from now looks like a good strategy, for Nike, I am still concerned about the competition. I have to eliminate that concern before I pull the trigger.
Thanks Oguz for this. MCD is on my watchlist to dollar cost average starting from around its current level.
Starbucks and others suffering due to lattes costing almost $7.00 +.
Airport $10.00
We just got a milk warmer/ foamer at home. I think the break even versus buying out was about 20 days. Enjoying a couple of lattes at home now.
Love the breakeven calculation, way to go!!!
Indeed, former CEO Schultz pointed out the US store experience but the main reason is that its coffee is too damn expensice for lower income groups.
I am just getting a plain cup of coffee and doctoring it up , not worth the foaming!
🤣🤣🤣
🥵🥵🥵
Amrita, can you please tell me more about - how liquidity increase leads to investors investing in riskier assets ? they can just as easily invest in bonds, yeah ? curious on why ?
It is about the equity risk premium. When the yields on risk-free USTs are strong, like they are today, investors actually have an alternative to equities. In fact, many investors will choose to buy Treasuries and T-bills instead, because the added risk premium of equities (not risk-free) is just not worth it. On the other hand, when liquidity is strong, and the yields on bonds go down (could be driven by QE), there is no incentive for investors to buy bonds at such low yields. With expanding money supply, they bid up the prices of riskier assets, such as equities to lock in higher gains than what an yield on the government bond will provide. Hope that answered your question.
got it - I deeply appreciate your time in responding. given weaker economic conditions, which leads to more investing in bonds, which leads to lower bond yield, which leads to investing in riskier assets - to chase yield !
The Federal Reserve has a tough job. They have to make hard, sometimes very unpopular, decisions.
Everyone wants low interest rates today, but most fail to see the long-term consequences.
We must pray that Trump doesn’t win the next election and turn the Federal Reserve into his puppet, as some media sources suggest he intends to do.
As I discussed here: lianeon.org/p/imagining-our-martian-gov…, there is a body of evidence that establishes that the more politically independent a central bank is, the lower inflation and the higher employment will be.
We need technocratic administration, not politician-driven sugar-highs.
Thanks J.K. Couldn't agree more that the Fed has indeed a tough job. On your point about central bank independence, I think the ethos starts to get muddied up, when a nation keeps on growing its deficits larger and wider, or as Stanley Druckenmiller says, "spending like a drunken sailor" and the Fed really has no other choice but to monetize the debt and keep interests low in order to stop government debts from further ballooning. Unless there is some serious measures of austerity taken with government deficit spending, I actually think that the Fed will become more and more politicized regardless of administration.
That's a good point. It leads to nowhere good
Saved for later reading!
Thanks Joyce. Feel free to reach out if you have any questions.
Thanks, Amrita. I will!
U r better than Morningstar and give better info than my Harvard class tbh
Amrita - does increased liquidity mean, investors invest in riskier assets ? can you tell me more ... loved this article
Thanks Deepak.
Thank you great question I asked that to Schwab yesterday the Denver office and I had trouble understanding what the risks of cash to pattern day trading are I only trade maybe 20 times a day max but with the economy and bitcoin on the rise I’ve been just doing pull five put in 5-30 I h have 300 in and have made 50 bucks my first three weeks
Wow! There is so much here to unpack! Thank you Amrita. Don’t you wish you had a crystal ball? 🔮
Thanks Charlotte. I think more than me, the Fed needs a crystal ball now more than ever. But, sure, I can use one. Imagine I predict all the right outcomes for the economy and the stock market. I will have my own show on CNBC, and my tower in NYC. Oh no, I am getting greedy. Back to work.
You Go Girl! (back to reality)🤗
The US economy is resilient. The indexes have recently hit new all-time highs, which is a good sign. Technical analysis says they've completed their bottoms. However, I admit that the gains were a little too excessive. The indexes (and most stocks) need to settle into an intermediate- to long-term trading range to pattern out those gains. That's what seem to be happening right now.
If in doubt, use stop losses at strong support levels :)
Thanks Denis.
Obaretin