Mike Wilson, Morgan Stanley’s equity chief, says part of the stock market has already pocketed a soft landing and pushed the forward earnings ratio of the S&P 500 to 21. But other parts tell another story. “Under the surface, the market has skewed much more defensively. The internals of the equity market may not be betting on a soft landing,” he said.
Bonds are not ratifying the bullish story. Two-year Treasury yields were trading 180 points below the Fed funds rate last week, the widest spread in 40 years and a red alert. “This is the bond market’s way of messaging to the Fed that they are late,” he said.
I do not wish to rain on Jay Powell’s parade but the Fed was forced to act. Its own Beige Book two weeks ago said economic activity was flat or declining in nine of the 12 Fed regional districts, up from five a month earlier.
Professor Tim Duy, Fed Watch founder and chief economist at SGH Macro, said the Atlanta Fed’s instant and stubbornly resilient snapshot of GDP fools a lot of people. The data lags. It is meaningless at inflection points. “If you hold on to the GDP numbers, you will drown,” he said.
The better signal comes from the fragile fringe of the labour market, which always sniffs trouble first. It began to flag pre-recession warnings months ago. Had the Fed known just how fast jobs were cooling, confessed Mr Powell, it might have cut rates in July. He also said the jobs data has become so inaccurate – and so frequently revised later – that the Fed now assumes the true gain in non-farm payrolls to be around 70,000 a month lower than first declared.
Ergo, it is already nearing zero.
My late-cycle signal is the US savings rate, today at 2.9pc and a whisker shy of the pre-Lehman nadir. Levels this low show that large numbers have depleted their savings and are stretched to breaking point. The lower it goes, the more violently it snaps back once fear sets in.
Mr Powell insisted that the economy was “strong overall” but struggled to explain why a jumbo rate cut was nevertheless necessary. “Powell seemed determined to paint a positive view of the US economy. But this does not square with the reality of labour market data.
We disagree with his view that recession risk is not elevated,” said Andrew Hollenhorst from Citigroup, who thinks the Fed may have to cut by more than 50 points at a time.
How this is resolved matters enormously for the world because if the Fed’s tight money policies have already baked in a slump, any short-term rally on Wall Street will soon evaporate and give way to a full-blown bear market. The contagion will spread through the global system and overwhelm all else.
The jury is out on this central question. Astute economists vehemently disagree as they always do when the cycle turns. Personally, I intend to enjoy the Fed party, but not stay too long.