The Powell put

An early bankers’ meeting in Hershey on Monday necessitated a four-hour Uber ride from home on Sunday night. An hour before the reserved ride, my driver cancelled, as did the next two. 24-year-old Kevin came through though and, excepting his Road Runner driving performance, he earned 5 stars. An Uzbek “asylum immigrant,” he came here through Mexico and means to buy a truck and be his own employer one day. The equity market had its own pedal to the metal this week. Going back to 1981, eight months after a first rate cut the market’s up by an average of 20% if there’s no recession, but down an average 10% if there is one. Usually the S&P is fairly flat in the 12 months before a rate cut. Not this time—the S&P 500 is up 26.6%, similar to the 24% rise in the year before the 1995 easing began, a rate-cutting cycle which (also?) did not accompany a recession. The Fed’s cut should help small caps, where the relative valuation gap between small and large remains wide. As an astute veteran advisor noted, it’s very hard to predict sector performance. Indeed, since 2000, in the six months after an initial cut, only pharmaceuticals have outperformed each time. As for the uninversion of the yield curve we’ve been hearing about, which typically would herald a recession: when the spread between 2-year and 10-year yields normalizes, recession follows within a year 58% of the time. When the 3-month and 10-year spread normalizes, recession ensues 78% of the time. (Not sure I like those odds.) Still, the setup looks bullish as we start to move seasonally toward November and December, the strongest months of the year historically. Furthermore, gross exposure remains on the light side and Election Day is typically bullish whoever wins.

Sometimes pounding his fist on the table when announcing that inflation was down (but refusing to take a victory lap), Fed Chair Jerome Powell’s 50 bps move was on the aggressive side. Maintaining that the economy remains strong—i.e., that this big cut wasn’t a hurried move to avert a downturn—Powell said 10 times that this was simply a “recalibration” of the Fed’s policy rate. For now, the central bank’s dot plot indicates an expectation to bring rates down a further half point over the course of its two remaining meetings this year. Powell seemed concerned enough about the labor market to move quickly, though, and this move suggests that the Fed would be more likely to surprise by cutting faster rather than more slowly. The eventual goal is the neutral rate, which can’t be known directly or with precision. Various forecasters seem to expect it to be 2.75%-3.5%. The Fed currently projects nominal growth of 4.2% by the end of 2025. If so, 10-year Treasury yields at 3.75% may have little room to move down from here. Extrapolating the Fed’s posture into the future, one could say that a cheaper dollar and an eventual asset bubble just became more likely and a hard landing now looks less likely. But if you want cause to worry right now, consider that in both 2001 and 2007 the Fed initiated easing cycles with 50 bps cuts three months before a recession arrived. Still, of 11 cutting cycles going back 50 years, five did not lead to recession within one year.  Though it would be loathe to admit this, one reason the Fed needs to fight hard against a recession is that Treasury debts are so high and Congress is so fractious that the central bank must play an outsized role in keeping the public finances in order. Though a fiscal reckoning awaits, lowering rates reduces borrowing costs and keeps a recession at bay—for now.

We have been hearing for some time that the consumer is getting stretched, with credit card delinquencies a frequently offered sign of malaise. Turns out that this is an instance of bifurcation, with better-off consumers doing just fine while less-affluent borrowers—whom stimulus money had temporarily enriched—struggle. August retail sales rose unexpectedly (more below), which probably comes down to the strong productivity growth we’ve witnessed recently. With low unit labor costs and wages rising faster than inflation, the American worker is shopping. Overall, consumers’ share of total assets in cash is little changed since before Covid. Consumers’ cash balances and net worth are back on their long-term trend growth rate. While this holds, employment (rather than the wealth effect) is likely to be the main variable in consumer spending. Weekly mortgage applications rose 5.4% in the week of September 13, the fourth-straight increase. While still high, 30-year rates are now 6.15%, approaching the 6% rate where both homebuilders and realtors expect housing market (more below) traffic to pick up. Given the centrality of housing to the business cycle as a whole, it’s hard to picture an unemployment-driven recession where housing activity is rising. In fact, economic growth appears to be rising (more below), which is excellent news since it’s especially over the next several months that the labor market is most at risk. Per Strategas, mortgage rates have turned negative relative to their 36-month average right about when recessions begin. So far that’s staying positive, but it’s getting closer to zero. Hmm. This week, I delivered my election presentation, “Make Politics Boring Again” (clever, don’t you think?) in crimson-red Birmingham, AL. These bankers were very concerned about geopolitical risks facing the next president, and the burgeoning debt with many more expensive promises from both sides. But an upbeat assessment was offered—AI-driven productivity gains in government will finally cut waste, fraud and abuse! “Government will take a lot of the same steps that every business is forced to take in terms of upgrading their systems and resources with software,” one gentleman said. “They will be so much more efficient, saving billions.” I love his upbeat attitude!  And early voting is on—this will be the first presidential election year since 1976 without either a Clinton, Bush or Biden on the presidential ticket (including VP).

Positives

• The era of expensive money is ending, for now The FOMC met and cut rates 50 basis points, initiating the long-awaited unwinding of its inflation-fighting rate stance. The median dot on the Fed’s Summary of Economic Projections indicates a further 50 bps decrease this year, 100 bps in 2025 and 50 bps in 2026, which would bring the fed funds rate to around 3%.
• Green shoots in the housing market The National Association of Homebuilders’ survey rose two points in September, to 41, breaking four straight months of declines. Single-family starts rose while multifamily declined. Nonetheless, and despite mortgage rates retreating considerably, sales of existing homes remain weak, declining 2.5% m/m in August. 
• Don’t count the consumer or the economy out just yet Retail sales rose 0.1% m/m in August, versus expectations of a 0.2% decrease. Industrial production jumped higher, rising 0.8% m/m in August, well beyond expectations of a 0.2% increase. The Atlanta Fed’s GDPNow tracker now forecasts Q3 to show growth at a 2.9% annual rate, up from 2.5%.

Negatives

• Regional Feds’ mixed bag The Philadelphia Fed’s manufacturing survey rose. However, using ISM weights on the survey’s components, the survey actually fell back into contraction, dropping 3.2 points to 49.3. The New York Fed’s Empire State survey showed a welcome increase of 16 points to 11.5, but labor conditions in New York remained soft.
• Whatever happened to onshoring? The US current account deficit grew by $25.8 billion to $266.8 billion in Q2, against a $260 billion consensus expectation. The current account deficit now stands at 3.7% of GDP versus 3.4% in Q1.
• Germany weakens Investor outlook in Germany fell more than expected in September, the ECB’s rate cuts notwithstanding. ZEW Expectations plunged 15.6 points to 3.6, against forecasts of a slight decline to 17. The reading continues August’s 23-point drop. Germany appears to be the weakest of the eurozone’s major economies right now.

What Else

Where is the money going? The money race has been pretty one sided since Harris became the Democrats’ standard bearer. In July, she raised $310 million to Trump’s $139 million. In August, her campaign brought in $361 to Trump’s $130 million. Biden, by contrast, had raised $127 million in June.

Where has the money gone? Next month, for the first time ever, net interest costs on the federal debt are due to exceed spending on defense. The debt currently stands at $34 trillion; it was $9 trillion when the Global Financial Crisis got underway. The next president will face expiring tax cuts and Affordable Care Act subsidies.

Divided we govern Currently, the most likely scenario is that the House will flip to a Democratic majority while the Senate will shift to the Republicans. If so, this would be the first time in the history of the country that both chambers flipped in the same election. Carter was the last president to have Congressional majorities from his party throughout his time in office.