By Benjamin Picton of Rabobank
Faith, Not Work(er)s
US non-farm payrolls, perhaps unsurprisingly, surprised on the upside. Employment growth in March was 303k, versus a consensus estimate of 214k and a revised February print of 270k. There was also a two-month net upward revision of +22k jobs. The lift in employment was enough to see the unemployment rate fall to 3.8%, despite a two-tick rise in the participation rate to 62.7%.
So, the figures are strong, which is no-doubt part of the reason why 10-year treasury yields closed the day 9.5bps higher (and 20bps higher on the week) at 4.40%. The underlying strength in labor markets must be starting to spook the Fed, because a number of speakers over the weekend seemed to crab walk away from the dot-plot projections that were issued less than three weeks ago.
Neel Kashkari said that he wrote down two cuts in his March projection, but it is “possible the Fed won’t cut this year”. He also asked the question: “why cut rates if the economy remains strong?”. Cleveland Fed President Loretta Mester told us that she still expects the Fed will be cutting this year, but cautioned: “don’t expect disinflation pace to match last year’s”. Dallas Fed President Lorie Logan said that she was “concerned that policy may not be as restrictive as assumed”, the Fed “should be prepared to respond if inflation stops falling” and that it is “much too soon” to think about cutting rates. Governing Board member Michele Bowman said that “inflation progress has stalled” and that she “won’t be comfortable cutting until disinflation returns.”
Granted, most of these speakers are noted hawks, and Kashkari and Logan aren’t voting members of the FOMC, but it does seem like we are starting to see a change in tone from policy makers. The signals being sent by oil and gold prices might have something to do with that.
Front-month Brent crude futures traded as high as $91.91/bbl on Friday before falling back below $90/bbl in early trade this morning. There is plenty of potential for that to go higher if Iranian threats of reprisal play out. Spot gold prices rocketed after the release of the jobs report to reach (another) all-time high of $2,330/ounce, but have since fallen by about $20/ounce. All throughout 2023 we saw gold prices fall on strong data and rising bond yields, so why has this suddenly reversed? The signal from the market seems to be fear that inflation could be poised for a second run higher, while the Fed has painted itself into a corner by providing forward guidance on rate cuts.
Kashkari asked “why cut rates if the economy remains strong?”. Why indeed. Even if we use charitable measures like three and six-month annualized readings for core PCE and the CPI index, we find that these indices bottomed in December only marginally below the 2% target, so it’s not as if deflation was an imminent risk. Admittedly, cutting rates three times with ebullient stock markets, rising commodity prices, a resurgent manufacturing sector, beyond-potential economic growth, generationally tight labour markets and a fiscal deficit of 6.4% (in an election year!) might seem a little mad. Especially when your own bureaucrats are warning about the sustainability of the debt trajectory.
Given the context, Fed assurances of three rate cuts in 2024 look to be faith-based, rather than being grounded in the imminently material. This is not a criticism: a synonym for faith might be ‘trust’, as in the Fed ‘trusts’ that the policy settings they have adopted will cause the trajectory of the economy to unfold as expected. Of course, trust relies on the credibility of promise-makers, and the price action in gold might be suggestive that the credibility of the central bank is being tested. One wonders what the Fed’s internal models are telling them about the state of the economy that gives them confidence that multiple cuts is the optimal policy path this year? Is there some Deus ex Machina set to descend from the DSGE model and solve the inflation problem in time for a June rate cut? Or is the Fed going to be cutting while inflation remains above target? Or not cutting at all, as Kashkari suggested?
The story looks different in other parts of the world. Canadian employment figures for March reported on Friday were substantially worse than expected (-2.2k vs a consensus forecast of +25k). This saw the unemployment rate rise to 6.1% from a previous reading of 5.8% and well above the expected 5.9%. This is getting into the sort of territory where it seems almost certain that the NAIRU lays South of the current rate. This at a time when Canadian composite PMIs show the economy edging further into contractionary territory and year-on-year GDP growth is printing at recessionary levels.
Likewise, EU CPI last week printed lower than expected (and the unemployment rate higher than expected) even after a soft lead in the German numbers the day before gave analysts the opportunity to revise down their forecasts. The producer inflation figures were even softer, printing at -1% m-o-m and -8.3% year-on-year. What does that tell us about what is going to happen to consumer prices in the months ahead?
Since late last year the supposition has been that it would be a footrace between the Fed and the ECB to be the first to cut. Given recent data, one could be forgiven for thinking that the market might have been getting it wrong for months, and that the Fed might actually be one of the last major central banks to cut rates (if they cut at all). If that turns out to be the case, staying short King Dollar might be a dangerous trade.
