As usual, today’s #CPI report created great anticipation and then introspection upon its release. It’s always amazing that a few basis points (bps), one way or the other, can have such a large impact on market perception, and presumably on the interpretation of how the @federalreserve will react to such a number. The truth, however, is that the #Fed considers a multitude of #inflation readings, with a higher emphasis on the Core PCE measure. Yet, we find ourselves at a point in time where the range of outcomes for inflation related to recently solid economic growth, to newly elected political officials, and to the consequential potential for higher tariffs and higher levels of growth, etc., has led to an enormous focus on this number.

Upon reflection, last week’s #JobsReport was, as always, interesting and helpful for understanding where employment currently stands, which is at the top of the priority list for the @federalreserve. However, the data is also challenging to interpret, in terms of true job growth, given distortions from recent hurricanes in the southeast of the U.S., labor strikes in the Pacific Northwest, and the uncertain impact of these events.

Call it the Couldn’t Possibly Ignore report. That’s how important CPI has been in the past few years, as it has kept markets on edge as to what it means for Federal Reserve policy and interest rates across the curve. It’s still important, but the Fed’s clear focus has shifted toward more balanced priorities, with considerably more emphasis on the labor market for judging how quickly (if at all) to move the Fed funds rate.

CIO Charts of the Week: The Economy Is Doing Better Than We Originally Anticipated

While many called for recession in 2024 due to recent weakness in the labor market, the triggering of the Sahm rule, and generally weaker growth prospects, last week’s GDP revisions from the @bea_news helped to quell many of those concerns for the time being. Real GDP was revised up from 22.9tn to 23.2 tn, thus highlighting that the economy is doing better than previously expected, boasting a 3.0% growth rate quarter over quarter for Q2 and a 3.2% growth rate for 2023. Almost more impressively, GDI, a measure often cited as the better representation of growth through the tracking of income rather than expenditures, had previously been running over $500bn below GDP! This growing discrepancy blurred the picture of the state of the economy and called into question the relative strength of households as they seemed to be spending more via GDP, but not making more via GDI. However, in last week’s revisions, GDI was revised up to match GDP!

The markets have been riveted with a singular focus on one number, as a reflection of the Federal Reserve policy stance, and the primary question has been whether the Fed would cut 25, or 50, basis points (bps) at today’s meeting. As if one number carried as much relevance to financial assets as Pi does to mathematics and physics, in determining a circle’s diameter to its circumference.

A Thread on Today’s Payrolls Report:

There are some jobs reports over the years that are acutely followed by markets and others that are more of an afterthought. Today’s was the former, and the market reaction casts no doubt on the employment data’s importance. We can see the market's focus shifting from inflation to labor market data in the term-premia being priced around important data releases. It is clear that the labor market data has now overtaken inflation as the most important focus for both markets and the Federal Reserve. While the recent labor market data is clearly softer, it is very far from a disastrous indicator of recession, hard-landing, or some pernicious foreshadowing of future consumer weakness. Rather, we continue to believe the job market is moderating from robust post-COVID demand. In fact, almost none of the recent increase in unemployment has been permanent job losers; rather, it was driven by temporary (weather-related) layoffs in August, which reversed this month, and a steady stream of new entrants.

In his conference speech today @federalreserve Chair Powell delivered a jumping off point for a shift in monetary policy that would start to bring the Fed Funds rate down at the next FOMC meeting in a couple of weeks. Specifically, his description of a more balanced economic condition, which has largely normalized and is consistent with pre-Covid growth and inflation levels, sets the stage for such a change in policy.

CIO Charts of the Week: We believe the recent return of chaotic markets likely has its origins in onerously tight policy, which has created increased vulnerability to crowded positioning and stretched valuations for risk.

With the benefit of hindsight, we would note that the first foreshadowing of fragility may have been SOFR spiking on July 2. Shortly thereafter, the US Tech sector, which had risen to >20% above its 200d moving average, reversed dramatically on the largest ever 1-week small cap > tech outperformance!

Today’s CPI report confirms a trend that has been in place for a number of months: inflation moderating to a more normalized run rate level of price gains, and one that should continue to build confidence for the @federalreserve that this part of its mandate has been durably tamed. Therefore, we think today’s and other recent data open the door for a September beginning of a rate cutting cycle.

A Deep Dive on Recent Data: While headline CPI data printed at -0.06% month-over-month and Core CPI printed at 0.06%, the real story of today’s CPI print lies in the services components. June represented another month of very low Core Services (ex-Shelter) readings, which has completely reversed the acceleration seen in the 1st quarter, and is now under the Fed’s 2% inflation target on a 3-month annualized basis 1/ Earlier this week @federalreserve Chair Powell delivered testimony before Congress that underscored the progress that’s been made in both bringing labor markets into better balance after the severe pandemic-era disruptions, and improvements achieved in taming the high inflation rates of that period as well- a narrative which today’s data continues to support. 2/

In a market that’s become obsessed with election results and the question of who will take on the job of leading some of the largest developed market countries, such as the U.S., France, and the U.K., last Friday we had a day of respite to focus on the broader employment picture for the U.S. What that #JobsReport showed us was that while political officials seem to be extremely focused on their own employment prospects, there is a very gradual, but persistent, moderation within the broader employment picture.

Why is the savings rate so low today? Debunking a common myth on ‘Excess Savings’…

There are several widely circulated ‘Excess Savings’ models that show the U.S. Consumer having spent down the above-normal savings accumulated during the pandemic. These models, which are ultimately only illustrative in nature, implicitly assume the natural Savings Rate is ~8% or higher. We believe those assumptions are far too conservative and fail to acknowledge the elevated levels of household wealth today. In fact, we would say that as compared to arguing all Excess Savings are depleted (orange line below) it is more reasonable to argue there has been no depletion of Excess Savings at all (purple line below). Of course, as with most things, the right answer is probably somewhere between the extremes and we believe it is best to look at a range of outcomes.

1/4 How could it be that Excess Savings have not been depleted at all? While many things can influence the Savings Rate (especially anything that affects consumer psychology in a big way), the primary driver in the U.S. over the past 40 years has been wealth (as measured by Net Worth/Disposable Income). It is intuitive that as households experience higher wealth, they feel less need to save. This relationship was crystal clear from 1985 – 2010. The post-GFC period saw a psychological shift towards higher savings, but the relationship returned once the economy finally recovered in 2018. For anyone wondering why the savings rate is so low today, look no further than the new highs in Net Worth/Disposable Income.

2/4

To elaborate on my interview last week on @BloombergTV, as well as my response to @elonmusk, a thread.

Restrictive policy rates have succeeded in slowing the rate-sensitive segments of the U.S. economy (including goods inflation), but a >5% Fed Funds rate is not doing much to slow the insensitive, services-oriented segments. In fact, given the unique historical context, we believe >5% cash rates are doing unnecessary damage to certain cohorts today and may even be supporting services inflation.

1/13 The @sffed visualized this very well in a recent analysis… the components of inflation that are “most responsive” to rates have completely normalized! It is the “least responsive” components that are responsible for the sticky inflation we are experiencing today... there is not much Fed policy rates can do about that.

2/13

Today’s much anticipated #CPI report provided greater detail on the current #inflation picture, and importantly, on what the @federalreserve is most focused upon these days, and unfortunately, it’s hard to see it as anything other than a #setback. Recently, it has become clear that the #Fed is taking on a patient stance with regard to #inflation coming down, but today's report was further evidence that it may take even longer for inflation to finally reach the Fed’s 2% target level.

Yesterday’s #CPI data was highly anticipated by #markets, and particularly whether the elevated shelter #inflation from last month’s data ended up being a quirky aberration within service level inflation that is still quite a distance from the Fed’s 2% intermediate-term target. What compounded this quandary last month was a very strange divergence between the Owner Equivalent Rent (#OER) calculation and that for general #Rent.

As was widely expected, the @federalreserve today halted the most aggressive policy rate #HikingCycle since 1980, leaving the Fed Funds range unchanged at 5.0% to 5.25%, a level that appears clear to us to be finally having an impact on the #economy. We think today’s actions represent a “Hawkish skip,” which implies that #policy makers are seeking more #data before potentially hiking rates again in July, or September.

Today’s #CPI report for May showed another very firm depiction of where #inflation currently resides in the U.S., with #coreCPI (excluding volatile food and energy components) printing at 0.44% month-over-month and 5.33% year-over-year. Meanwhile, #headlineCPI data printed 0.12% month-over-month and came in just above 4% year-over-year, with declines in #energy components and some food prices being offset by gains in #shelter and used cars and trucks.

We’ve seen the pace of #payroll gains decelerate to roughly the monthly trend pace from the last expansion; consensus has been waiting for this moment and expected a 195,000 job gain in May, but the data printed considerably stronger at 339,000 #jobs gained. The three-month moving average of #nonfarm payrolls sits at 283,000, down from 334,000 jobs at the start of the year, but what the #LaborMarket imbalance needs is more supply and more slack.

Today’s #CPI report continues to depict #inflation that is just too high for most people’s good, especially the @federalreserve’s. In fact, the report showed that #inflation remains remarkably sticky, which doesn’t correspond to virtually any practical thinker’s timeline of when it might be expected to start to come down further.

A week ago, after hearing #ChairPowell’s testimony before Congress, all eyes were set to be on today’s #inflation data, which presumably would help market participants better understand the #FOMC’s policy reaction at its March 22nd meeting. What a difference a week makes these days! Of course, all eyes are still on today’s data, but now there are many other things we need to consider (such as #FinancialStability concerns), when judging the reaction function of the @federalreserve.

Today’s #JobsReport was very solid, but like is often the case in the movies, it’s very hard for the sequel (today’s report) to match such an unexpected hit (January’s revised 504,000 jobs gained). Still, a nonfarm #payroll gain of 311,000 jobs is quite good and having 815,000 jobs created so far this year after the #economy has already created 12 million #jobs over the past two years is pretty amazing in its own right.