What the Fed's Lack of Progress Means for the Markets

Jerome Powell testified before Congress this week in what was clearly an attempt to prepare everyone for the start of interest rate cuts in a few months.  He noted that, “holding rates too high for too long could jeopardize the economy…and unduly weaken economic activity.”  Hmmm.  So much for the Paul Volkeresque tough guy approach to central banking.  Let’s revisit some of the data and consider the real message.

Below you will find the CPI data since June of 2023 on an annualized basis...

June 2023 3.0%

July 2023 3.2%

August 2023 3.7%

September 2023 3.7%

October 2023 3.2%

November 2023 3.1%

December 2023 3.4%   

January 2024  3.1%   

February 2024  3.8%   

March 2024 3.5%    

April 2024 3.4%    

May 2024 3.3%

What is fascinating about these numbers is that in December of 2023 Powell announced to the world that due to the Fed’s progress on combating inflation the Fed was set to begin its policy easing and would likely cut rates three or four times in 2023.  His talk of lower rates unleashed the latest stock market bubble, which has persisted despite the Fed’s reluctance to lower interest rates.  Yes, artificial intelligence came to the rescue and turbo-charged a market that was in the middle of a major correction.  From my experience, I can’t recall another situation in which we had a fresh bubble in the middle of a prior bubble bursting.  In any event, I don’t believe that we need to be skilled statisticians to see an utter lack of progress in combating inflation over the past year.  Yes, inflation has dropped significantly since the 2021 and 2022 savage levels of inflation that Powell had proudly pronounced as transitory.  Nevertheless, what should be clear to even the most informal analysis is that the Fed is making no more progress on inflation now than they were last December.  

I point this out not to attack Powell, who arguably has the most difficult, most thankless job in the world, but rather to objectively demonstrate that Powell is clearly going to lower rates, and for him, one excuse will be as good as another.  He just needs to creatively come up with a spin that most people will accept as a justifiable excuse to start dropping interest rates.  Powell is very smart, and he is a master at creating this “spin” to justify the Fed’s next move in rates.  He is simply setting the stage for a shift from “higher for longer” to “it’s time to ease due to our great success in taming inflation.”  He won’t want to frighten people by focusing too much on the downside risks in the economy.  Rather, he will take a victory lap and claim credit for the Fed’s wonderful work in vanquishing the ravages of inflation.  Put simply, Powell will effectively be saying, “inflation be damned.  I am cutting rates, and we will all be better off because of it.  Inflationary pressures have been crushed by our brilliant efforts.”  Whether or not it’s true is irrelevant.  Of course, a resurgence in inflation after a few rate cuts would prove to be catastrophic for many reasons.

Please have a look at the two following charts.  The economy is in fact softening – quickly – and the federal deficit levels make higher interest rates crushingly painful.  The chart showing the unemployment rates over the past twenty years is quite clear.  Unemployment is starting to steadily trend higher.  It is coming from a lower base than we had just before the Great Recession, but the trend is clear.  Moving averages confirm the current trend, and the economic growth numbers are softening quickly.  In fact, as you can see in the Fed chart showing the Sahm indicator, the Sahm rule is about to get triggered.  This indicator is remarkably reliable, and it signals a recession when the three-month average of unemployment rises more than .5% above the low level during the previous 12 months.  

I discussed the Sahm rule on June 25, 2024, and it is slowly climbing towards its critical trigger level.  This rule has been largely infallible for the past 65 years.  As an example, the current level is essentially the same level that we had in February of 2008, and I think we all know what happened to the US economy after February of 2008.  For the past 65 years, nearly every time the indicator reached its current level of .43%, a recession followed.  The only exceptions occurred long AFTER a recession when the unemployment level had a bit of a bounce as the economy stabilized.  

The following chart from Bloomberg gives us a very clear picture of the quickly deteriorating conditions in our jobs market.  It is getting much harder and taking much longer for unemployed workers to find fresh employment.  Powell did concede that although the economy is strong, there are growing risks from a cooling job market.  He simply chose not to go into much detail, which is consistent with his general strategy of trying to focus on the positive.  There are actually a wide array of economic factors that are concerning.  Aside from the time it is taking unemployed workers to find new jobs, there are a variety of other signs of weakness.  Recurring unemployment claims rose for the ninth straight week, and the sharply declining number of job vacancies is significant. In fact, private sector job openings have fallen to 7.1 million from 11 million, the peak we had in 2022.  There are now 1.2 available jobs for every unemployed worker, in line with 2018 and 2019 levels.   Still, Powell refused to point out the elephant in the room – full-time jobs have been declining every month.  The job market has definitely softened a lot.  The net increase in jobs has been due to the sharp rise in part-time jobs which have only marginally offset the decline in full-time jobs.

Additionally, the nonfarm payroll data has been revised downward fourteen of the last fifteen months!  These adjustments are starting to feel like more than a coincidence.  If I were to put on my cynical hat, then I might suggest that some powerful people have a vested interest in showing data that portrays a stronger economy than we actually have.  Most people tend to focus on the headline numbers, however misleading they might be, and they are clearly misleading now.  The headline numbers both overstate the number of jobs and misrepresent the types of jobs that people are getting, so the revisions tend to get lost in the noise.  In fact, aside from government hiring, the job market is not just cooling, it is cold as far as full-time employment goes.

There are some other unpleasant things taking place now in the economy.  Credit card debt is at a record $1.1 trillion dollars, and delinquencies of more than ninety days have reached 7%, the highest level since 2011. The residential housing market is moving at a snail’s pace, and the commercial real estate market is truly suffering. Nevertheless, against this worsening economic backdrop, and with a savage election season fast approaching, the stock market continues to climb ever-higher.  

The S&P500 has posted 36 all-time highs this year, and it seems intent on climbing still further.  As I have written previously, I would love to see one final, climactic surge higher once the Fed finally starts to cut rates.  I would expect the top that we experience in the stock market at that time to be a very, very important top that leads to a protracted, major corrective cycle.  

In other markets, gold and silver have recovered strongly from their recent lows, and they look to be coiling for a continued surge higher.  Silver has rallied about 8% from its recent lows, while gold is up several percent.  These two commodities will really be in play once the Fed finally starts to cut rates.  The fact that they have been so strong despite Fed Funds being above 5% is truly remarkable, and it speaks volumes about the powerful underlying demand for precious metals.  China and India have been steadily increasing their gold reserves, and over time they will continue to buy more.  The upside for precious metals over a long-term time period is very significant.  The exploding US deficits will continue to frighten investors into shifting their savings and reserves from fiat currencies -- including the US Dollar – into gold.

On March 3^rd of this year, I warned my clients that Bitcoin was getting set for a corrective period.  We had just rallied from 25,000 to 70,000, and I was convinced that we were going to enter a broad corrective cycle from that 70,000 level.  Markets that have parabolic rises like that always correct, and my instincts told me that it was time to lock in profits and either go flat or play for a nice sell-off.  It is tough to time these things perfectly, but I think that the sell-off this week was likely the bottom of the correction. Just as I expect gold and silver to shine, I also expect Bitcoin to shine for quite a while.  I have a variety of potential targets for Bitcoin, but I think that a price around 90,000 should finish this part of the move.  It is likely time to get long once again.

In terms of currencies, the unanimity of views about an imminent yen collapse is astounding.  Yes, Japanese debt levels are frightening, but it is a major mistake to underestimate the strength and resilience of the Japanese people.  They have enormous holdings, and they absolutely have the power and the resources to drive dollar yen much, much lower if they decide to do so.  In fact, I would welcome another sharp weakening of the yen because I would like to increase my long-dated option positions that are betting on a yen recovery over a long period of time.  The problem for the United States is that the Japanese government pension is sitting on $1.3 trillion of US government bonds. If the Japanese decide to unload their US bonds and their dollars, then dollar yen will collapse. I will write more about the currencies next week as there are many very interesting trades that are lining up now.  

In the meanwhile, I wish you all the very best of luck with your trading.

Andy Krieger