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Marc Chandler speak to James Foord about why he’s taking a look at the Fed funds futures strip (0:50), concentrating on annualized rate for inflation outlooks (4:20) and why an economic downturn is a various story than sluggish development (7:15). This is an abridged variation of our recent discussion, Falling Inflation, Dollar Dominance And PBOC Moves With Marc Chandler.
Transcript
James Foord: Today, I had the enjoyment of talking to Marc Chandler, the Chief Market Strategist at Bannockburn Global Forex. He is likewise a fellow SA factor and today, we had a fantastic discussion about the macro outlook for the U.S. economy, the outlook for Fed policy in the future and what this implies for stocks.
Marc Chandler: So we’re taking a look at the Fed funds futures strip, and I’m taking a look at the January agreement. And the factor I take a look at the January agreement is due to the fact that the December agreement due to the fact that of the year — due to the fact that of a number of things. One, you need to remember that the agreement settles not at the target rate, however at the reliable typical rate of the Fed funds.
So, they’re taking a weighted average of the money deal of Fed funds market. And so that’s where it settles at. And because the Fed treked rates in May, the typical reliable Fed funds rate has actually been 5.08%.
And when I take a look at where the marketplace says, take a look at the January agreement, the marketplace today, as we speak here, is at 5.12%. And so that informs me that it’s just 4 basis points on top of the existing rate. And so to me that’s a really little opportunity of a walking being priced in.
But you might have – and some individuals have actually recommended a push back and they state, no, what I’m missing out on is the federal walking rates, in July, possibly, and after that cut them prior to completion of the year. So we’re back where we are now. And I believe while it’s possible, I believe it’s extremely unlikely.
The Federal Reserve would be raising rates and after that cutting them. I believe it presupposes some sort of shock. And naturally, you understand, and what we do, it’s beside difficult to anticipate a shock. I indicate, the shock by meaning is a surprise.
And so, while it’s possible that the Fed will raise rates in July and after that cut them prior to completion of the year, I believe it’s most likely that by the time we get to that July conference, which occurs late in the month, we’ll see CPI fall even more.
Remember what occurred last June, the CPI increased by 1.2%. This will leave of the 12 months contrast, be changed by something much lower, state 0.2, perhaps even 0.3. That’ll bring the rate down, the heading year-over-year rate to something near to state 3.2% to 3.3%.
So in addition to the low inflation by the time the Fed reunites, at the end of July I believe we’re going to have some weaker financial information. I believe the U.S. economy is peaking now, here in Q2, around 2% development, provide or take a little bit.
And that in the 2nd half of the year, a few of the tightening up forces, whether it’s trainee loans needing to be repaid for the very first time in numerous years, whether it’s the tightening up of financial policy as the rate for the financial obligation ceiling drama to end, whether it’s simply these extension of a few of these drags from – whether it’s from bank loaning, tighter loaning conditions, whether it’s the contraction in money supply M2, whether it’s the collapse and the leading financial signs, will get next week once again. And if you take a look at the six-month rate there, and we’re at a rate that we have actually just seen throughout economic downturn.
So, I’m taking a look at the economy almost be an inverse of in 2015. Remember what occurred in 2015? Economy contracted the very first half of the year, grew in the 2nd half. Now I’m recommending they’re going to grow here in the very first half of the year – that cake is baked. But I’m taking a look at a weaker economy.
So by the time the Fed fulfills in July, it is tough for me to see how they resume with falling inflation and weaker development.
JF: Right. Yeah. Absolutely. It looks like a great deal of what’s driving the narrative today is naturally that disinflation, right? So that inflation level coming down. At the same time, you’re talking about the strength of the U.S. economy.
So, would you say that maybe we’re entering a period that the market would be quite favorable about, which is that lowering inflation together with the slightly weakening economic data probably pushing the Fed to cut.
So first of all, what is your outlook on inflation? Do you think that the Fed has conquered inflation?
MC: Yes. So, inflation, I think it’s a tough thing, partly because there’s so many ways to slice and dice the data. What I have found most helpful is to look at what we’re doing at an annualized pace. So where are we at an annualized pace? And in fact, in the first five months of this year, the CPI has risen faster than it did in the second half of last year.
So, I think that’s a concern. So, I guess if I had — if you told me, like, you nominated me to be at the Federal Reserve for today’s meeting. I’d probably be inclined to hike partly because I think that the way the Fed is thinking about it is, I think they recognize that they were behind the curve to take their foot off the gas by the QE and a little bit slow out of the box to raise interest rates.
I think that the Fed thinks that inflation credentials have been scarred, or scratched, or deteriorated a little bit. And I think the economy has proven more resilient than the Fed has thought. And so I would be more inclined to raise rates, thinking that I’m done with today’s hike.
But I think that the Federal Reserve is still like wrestling with this. And so, I don’t think inflation is conquered, but I do think that inflation in the second half of the year is going to be a bit tougher for this base effect because of inflation so low, below 3% in the second half of last year, I think that when we look at the base effect for the second half of this year, it’s going to be a harder comparison. And so I think the most of the decline in inflation might be behind us.
Getting it to come down from like 8%, to say what I think is going to be 3% or so, when we get this June print, that’s one thing. But to get it to the 2% target is a bit different. And here’s what I’m going to be watching with those dot plots from the Fed, is when you look at what they forecast in March, they still have inflation above their target next year.
But they have signaled by looking at their median forecast, they’ve signaled more than one cut next year. And so, I think when we talk about the market pricing in a cut, I don’t think that this year is very likely, but I think a cut next year is very likely.
JF: Now when people think about the Fed cutting, that is usually in anticipation of weaker data or recession. This is something that has been talked a lot about. I think, as you said, we’ve had a bit of a surprise towards the beginning of this year with growth being a bit more robust.
How do you feel about the timeline for that recession, soft versus hard landing? Where do you fall on that debate?
MC: Yeah. It’s funny. I even thought that we would have a recession by now. I thought that, so the first two quarters of last year contracted, two quarters back to back. But it turned out to be a bit of a statistical fluke, having to do with the trade and inventory management.
Economists typically don’t admit they’re wrong. At least not the economists I know. What they typically do is, they just keep pushing out their forecasts. And so the recession from 2022, now it’s down likely second half of 2023, or into 2024.
I think what’s hard about forecasting a recession right now despite all these economic indicators pointing to weakness, despite the strength of the labor market, I’m concerned that next year, as you know, is a presidential election year.
And typically, that is not when the U.S. has a recession. Efforts are done to prevent that from happening. And so slow growth is one thing, a recession a different story. And I think that there’s some favorable developments. I mean, besides the strength of the labor market, I think that the easing of supply chains.
So far, the drop in oil prices, drop in commodity prices in general, I think that all generally like are helping to promote even if it’s weak growth. I think you raised an important point too. I think what’s like the outlook going to be?
So, to me, what’s happened is, it’s like the U.S. economy is a snake. And it ate a doe. And that is the shock that we’ve had. Whether it is the lockdowns related to COVID, whether it’s the uneven re-openings, Russia’s invasion of Ukraine, the Chinese economy, all posing shocks, we got weather shocks as well with these Canadian fires, low water in the Panama Canal.
So, as the U.S. economy, the snake, absorbs these shocks, eating that baby doe it takes a while to like, work its way through the system.
And I suspect that on the other side of this, we’re going to return to what we call the great moderation. Before the great financial crisis, we had a long period of slow growth, low inflation. And I think that that is, to me that the most likely scenario is return to slow growth, low inflation, low interest rates. Even though I know many people disagree with me.
They think that we’ve broken into this new higher inflation world, whether it’s because of the end of globalization, whether it’s because of various reasons they’ve come up with why we’re going to be in this quasi-permanent higher inflation paradigm. And I think that – I think while it’s possible, I still think that’s more likely that we go back to the forces that were dominating before these shocks, that produces low growth, low interest rates, low inflation.
JF: The idea of liquidity being drawn out of the market due to the debt ceiling, right, because the debt ceiling was reached, the government is now going to refill that TGA, the Treasury General Account, kind of draining liquidity out. How do you see the outlook for stocks and equities in light of those two events?
MC: Yeah, Just an amazing story. People talk about American exceptionalism. And I don’t know any other country that could go through this debt, authorized spending and then not having congressional approval to pay for it. What a bizarre set of circumstances.
And despite how bizarre it is, and despite Fitch putting the U.S. on credit watch for a possible downgrade of it, I think that we should expect this to happen again.
Partly I think that, yes, it’s kind of bizarre thing, because in Europe, for example, or Japan, and the parliamentary system, this would seem to be almost impossible to happen. But the U.S. presidential system where the party in the executive branch, doesn’t necessarily have a majority or have control of the legislative branch to produce these kind of weird outcomes.
At the same time, I think both political parties have used the debt ceiling debate to try to exact concessions from the other party. And so neither party, I think really want to give it up even though it appears to me to be a dangerous game that the U.S. loses. I think it sort of mars our credibility on the world stage, when we have to get so close to this brinkmanship tactics.
But you raised an important point and that is sort of what is going on with liquidity. And we know that the Federal Reserve is engaged in quantitative tightening with letting the balance sheet shrink.
Your point about the debt ceiling as the resolution, a flood of T-Bills hitting the market already. Now between last week and this week, I think something like $750 billion worth of bills and coupons have hit the market.
And the question really is, how are these paid for? If these are going to be paid out of bank’s deposits, banks reserves, you get a tightening of liquidity conditions. But if it’s going to be paid out of foreigners buying U.S. assets, then it’s going to be paid partly by deposits coming back into the banks, that the squeeze on funding maybe a little bit less, especially if we see the reverse repo facility where a lot of money is parked.
So it’s still not clear to me, but I think, to me the interesting development is that despite this, despite the rise in the U.S. two-year yield, the bill supply, which have all been fairly well received so far.
Despite all this, the stock market now, the U.S. stocks are at 20% or so off their lows. The European stock market is near its highs for the year. The DAX is near their multiyear highs. The Japanese stock market has also done incredibly well. I think this might be we might be at the highest since the early 90s or so.
So broadly speaking, I think the idea is that whether the Fed goes July, whether ECB goes in July, or maybe later this year, whether the Bank of England still looks like it’s got more wood to chop, yet the market suspects that the central banks are done or nearly done – – so they will be done, state, or just about done by the end of Q3.
And I think the marketplace, this is one of the things to think about, conceding or framing the markets. It’s that anticipatory mechanism like discounting future events, future probabilities and the market I think is looking past towards, what’s 25 basis points, even 50 basis points in the big scheme of things.
And the market I think is looking past that. And I think that’s why I think we’re seeing equities rallied so much in the face of rising interest rates, inflation, and the fact that central banks aren’t rather done yet.
