While the financial community engages in heated debates about whether or not the Fed can soft-land the economy, we continue to get a flow of incoming data flow that suggests they already have.
This is it. This is the soft landing. We’ve been in it for 9 months.
Aggregate Weekly Payrolls (Private Payrolls * Hours * AHE = nominal income proxy) are running at 5.6% on a 3mma on-year-ago basis. The year-on-year rate is 5.4% and YTD y/y is 5.4%.
Given that the run rate for this metric during the lowflationary 2010-19 cycle was 4.4% (as core PCE averaged 1.6%), running ~1% higher implies core PCE inflation ~0.5% above target, almost exactly what we saw last week with our other nominal benchmarks, final sales and personal consumption.
Growth in the nominal economy is consistent with inflation about half a percent above target. That’s little more than an annoyance from the Fed’s perspective and absolute nirvana for the equity values of corporatiuons that apply a bit of fixed-rate leverage to generate earnings.
If you view the data from a static perspective, the only reasonable conclusion is that the Fed has nothing to do here. Hence, the “data-dependent” Fed does nothing.
So, this is the soft landing. We’re living it. Why do you think equities go up every day? Because it doesn’t get any better than this for stocks.
Enjoy it While it Lasts
I guess we should’ve known that the preemptive pivot based on a forecast of declining inflation was never gonna work. There is simply no way to get comfortable with the idea of on-target inflation with nominal growth running above 5%. In other words, “inflation confidence” was always going require some degree of economic slowdown.
It is now clear that there will be no preemptive easing. The Fed will do what it has always done: hold rates until it sees the whites of the eyes of recession.
Recession might seem like a wild-eyed forecast to those extrapolating the current rate of nominal growth. But it’s hard to envision the economy exiting what has now been a 5% steady state for a nearly a year downshifting to a prefect 4.0-4.5% and simply stabilizing there in the absence of an aggressive policy response to halt the downward momentum. And there is not much scope for an aggressive policy response until it’s too late.
The economy “landed” 9-12 months ago. It’s not quite soft enough for the Fed’s liking, but it’s the landing we got. And once the economy begins decelerating from here there is no reason to expect it to stop.
And Friday’s payrolls number notwithstanding, there are gathering signs that economy is decelerating.
As for asset markets:
· As long as everything‘s fine everything will be fine. Stocks will love 5% nominal growth for as long as it lasts.
· While I’m in the slowdown camp, I do not like shorting stocks on the view. I much prefer a long rates expression.
· If the slowdown takes longer to emerge (as it has), a long rates position will bleed a bit, but so long as there is no risk of nominal growth acceleration - and I’m highly confident there isn’t - your downside is limited in bonds.
· If you’re short equities and we continue to get steady, nirvana-level nominal growth, you’re gonna get wrecked.
· The time to consider equity shorts will be after the slowdown is evident. As we slow, the market is likely to believe for a while we’re entering the soft-landing zone, when in fact, we’ll be exiting it. Expect a short-lived “bad is good” equity rally as a slowdown sufficient to move the Fed comes into view. That will be the rally to short.