Even with various Fed spokesmen on the tape in recent weeks, it is difficult to get a sense of where the consensus stands regarding a policy rate reduction at the next Fed meeting, which concludes on 10 December.
As Bloomberg News noted last week, the past year or so has seen prescriptions for where rates should end up diverging by the most since at least 2012, when US central bankers started publishing their estimates. That’s feeding into an unusually public split over whether to deliver another cut this week, and, indeed, what comes after that.
Chair Powell has signalled a degree of circumspection with respect to a policy rate reduction at the December meeting, but, presumably, in the wake of divergent opinions on the Fed’s policy rate-setting committee, the Federal Open Market Committee (FOMC), he has been careful not to reveal his hand.
Having said that, a key Powell ally, Federal Reserve Bank of New York President and FOMC Vice-Chair, John Williams, has appeared to favour a cut when the FOMC meets next week.
And the current median “dot plot” implies a cut at the December meeting. (A new “dot plot” will be issued at that meeting.)
Of course, there are complications insofar as the Fed is “flying a little bit blind” given the informational gaps occasioned by the lack of official economic releases in the wake of the Government shutdown.
As I have stated in the past, my view, given the current “dot plot” and given other data from non-official sources, is that the Fed gets over the line for a cut at the December meeting.
That is not to say that I think it should cut the policy rate. Any rate reduction has the potential to be “messy” unless and until there is demonstrative evidence of falling inflation.
However, even while inflation has remained “sticky”, the labour market appears to be cooling.
The ADP weekly payrolls have been consistent with a softening labour market, and last night’s ADP November monthly payrolls report showed employment actually fell in the month by growing by only 32k (versus the 5k increase expected) and follows a modest 47k increase the previous month. The ADP report is sometimes dismissed (too easily in my view) because of its poor record in foreshadowing month-to-month movements in the Bureau of Labor Statistics payrolls measure. However, it is just as good a measure of the state of the labour market as the payroll report. Moreover, that November measure certainly would have caught the eye of FOMC members.
The November Institute of Supply Management (ISM) manufacturing index (PMI) released on Monday paints a weak manufacturing picture: the index came in at 48.2, the lowest since July, marking a ninth consecutive month of contraction. The employment component slipped to 44.0, consistent with ongoing manufacturing job losses (50.0 is the neutral point between expansion and contraction). The prices component, meanwhile, increased to an elevated 58.5 (indicating accelerating inflation in the sector).
The ISM non-manufacturing index released overnight paints a better picture, with the overall index remaining consistent with expansion at 52.6 (up from 52.0 in October). However, the price component remains elevated at 65.4 (again consistent with a further acceleration in inflation, even if it was less than the 70.0 recorded in October), and while the employment component improved a little to 48.9 from 48.2, it remains consistent with some modest cooling in the non-manufacturing labour market.
So, with an eye to the labour market side of the mandate, the Fed may find the path of least resistance a further 25 basis point cut.
But the critical issue remains elevated price growth, and that is why a cut might be “messy”. Indications are that inflation remains “sticky” and that the path to lower policy rates remains a complicated one, replete with the prospect of a policy error.
The aforementioned data mean that a ‘stagflation-lite’ macro scenario remains credible.
An environment of “sticky” inflation and attendant elevated bond yields combined with slowing economic activity and employment is not a cocktail that equity markets would ordinarily find palatable.
However, equity markets have by and large been focused on structural elements – the so-called “mega forces” – that can be big drivers of equity market performance.
Arguably, it is these structural “mega forces” led principally (but not exclusively) by the AI revolution that are the principal drivers of equity market performance this year, at least since the “Liberation Day” tariff announcements.
There are others: a fracturing world has buoyed defence stocks; a tendency toward “oligopolisation” / “monopolisation”, particularly in emergent tech industries (think Meta, Google, Uber, Amazon, Nvidia) has boosted returns from those stocks.
That might still be the dominant theme going forward.
But an increasingly fraught macro picture that appears to indicate emergent ‘stagflation-lite’ may well assert itself at some stage.
Stephen Miller is an Investment Strategist with GSFM. The views expressed are his own and do not consider the circumstances of any investor.
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