Blain’s Morning Porridge 16th September 2024: Fed Week – Digital Event Prediction Tools.
“Interest rates set the mood and define the fears of the whole economy.”
This week will see the Fed start to ease, but the question is pace? Do they go big and create potential concerns on a hard landing – potentially scaring the horses – or do they hold a steady course, a modest ease to guide markets that rates are normalising. Whatever the Fed does needs coordination with policy on the future path of the economy.
First up, delighted to report I completed my 2.5 mile swim raising money for Heartbeat, a cardiac care charity on Saturday. I will send round a short note later. The donations page is still open: Bill’s Pub to Club Swim
Back in markets….
The market is awash in hyperbole this morning as this Fed-dominated week begins. Much talk like “descending from the peak of the rates mountain” from 5.25% to 4.75% or 5%…. Old bond dogs like me know 5% rates are not high. They are normal. There are sound reasons why there should be a real cost of money – not least in teaching fiscal discipline! Free money – as we experienced during QE from 2010-2022 created all kinds of issues, which the market is still to properly “cold turkey” from.
The surveys and media say the market is 50/50 on the scale of Wednesday’s Fed cut, evenly balanced between a 25bp/50 bp Fed ease. It feels marginally skewed towards 25 bp from my perspective – I’ll discuss why below, but most banks also think 25bp is most likely, largely because the Fed is supposed to be cautious, conservative and never to show panic or other emotions. Others say the Fed doesn’t want to run any political risk that might favour the incumbent political party – although at this stage of the game Donald Trump will likely claim credit for a bigger ease on the basis of his claim of alpha-dominance over Jay Powell.
However.. when I used the latest in AI DEP (AI Digital Event Prediction – “DEPtec”) to discern the likely scale of the ease, the coin came up heads, which means a 50 bp ease. Curious. I probably should invest in a data centre or two to train the coin more thoroughly on 300 years of economic history… It’s just a dumb binary switch which is completely not the same as billions of dumb binary switches on a chip… surely…
How will the market react to a 50 pb ease?
- Bond traders, being suspicious pessimists (for good reason) will see it as a clear sign the Fed lost on control on the glide path to a soft-landing, that the economics will call for even more rigorous action and thus rally into rising expectations of deeper cuts – and they will point to whatever the dot-plot says about the future rate environment, placing their bets accordingly on the pace of US slowdown.
- Equity players, being optimists will see it as another record on the deck and another line of shots on the bar. Party on. However, an increasing number of equity players are tired of the non-stop party and are seriously wondering just how solid many of the current market themes like AI, Chips and such may be. Many have already rotated into the black coffee of fundamental stocks based on what’s actually happening in the real world, rather than just Silicon Valley.
- Some C-Suites will be thinking, excellent.. let’s lever up with more debt, buy-back more stock and give ourselves bigger stock options.
Simplistic – but you get the vibe. My own guess is a 50 bp ease will ultimately trigger a sell the fact the moment.
Maybe the question to ask is: Is there any real reason for the Fed to ease at all?
Aside from the potential inflation threat from increasing threats of geopolitical cold war, diminished global trade, rising tariffs, increasing wage demands, and suborned supply chains, some say these are balanced by deflationary threats like a coming collapse in oil and energy prices – which will apparently be accelerated when Trump wins the White House, declares peace in Ukraine and Russian oil exports trigger a deflationary boom. Please… whatever these people are smoking… they should stop.
My base case is we continue with a short mild recession/downturn before the markets adjust to a higher growth and recovery outlook in a normalised interest rate environment. If there is an economic shock – which could included a dramatic shut off in global trade from tariffs, then I’d put a deflationary bust, or more likely a stagflationary bust, as the highest risk probability as the global economy tries to reset.
There is a strong argument that a big Fed ease will decrease the pressure on consumer debt, bringing down mortgage costs, credit-card debt and auto-loans, freeing them up to start spending again. Or, is it more likely struggling consumers will use lower rates to simply stay afloat and continue to repay debt rather than spend money? At the same time they will increasingly be agitating for higher wages and pay – which realistically can only come from productivity gains.
The problem for corporates is much the same – lower rates could simply mean a delay in the inevitable death of Zombie firms that are basically bust and struggle from one refinancing to the next. Much of the overleverage in the system is hidden from plain sight in the Private Equity markets where PE managers are struggling to exit the firms they over-levered with debt to pay them dividends. They will see lower rates as a “pretend and extend” opportunity to refinance or exit. Firms that are overlevered don’t have the facility to invest in higher productivity, meaning pressure to keep wages low.
The real issue is what do artificially low interest rates do to corporate behaviours? I’ve argued many times that ultra-low rates distort rational business decisions – for instance; stock buybacks are cosmetically a better return option than a new, highly productive but risky factory in times of low rates.
If the dot-plots are right, and US rates trend into 3% territory next year – I would not be in the least surprised to see US corporates continuing to offshore their production and running stock buybacks, rather than investing in productivity gains (new factories, robotics, AI, staff training) in the US. They will do what is cheap and pushes their bonuses highest.
A 25 bp ease feels a more sober option.
- If gives the Fed the option to continue discipling the markets to normalised interest rates.
- It’s a steady hand at the tiller.
- It shows no sign of panic.
- Jobs may be trending lower, but there is no real sign of insipient crisis in the short-term.
- It can act if the situation deteriorates.
Medium/Long Term is more challenging as the global economy enters a new long-term cycle.
How does the Fed – though its one policy instrument – rates – encourage growth in the critical growth sectors of the economy, which like it or loathe it includes green technologies, but also energy security, defence and border security, while also ensuring the US can continue to lead in technology. These are the areas when government policy is critical, the Fed just enables it to happen by controlling the price of money.
The questions voters should be asking the candidates is how will the US grow its green energy and energy resilience, while maintaining the excellent of US armed forces and the strength of its alliances, while increasing national resilience through energy and climate transition policy, health care, infrastructure, etc. Do these things well and the economy will keep growing strongly into the next cycle.
These are all real things – if they fail we will know when China has won when its beating the US in all these areas… It is already clearly doing so in EVs.
Out of time and back to the day job…
Bill Blain
Author of the Morning Porridge, founder of Wind Shift Capital
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good clarity or whal…?