Stop. Just stop.
The narrative that the Federal Reserve is going to “pivot” and slow its inflation-fighting interest rate tightening cycle or pause or even start cutting rates soon is not going to happen.
For one, the U.S. two-year yield, an indicator of expected near-term interest rates, is higher by about 30 basis points in the five days since various market players and many in the financial media revived the dovish Fed pivot story.
A stronger than expected September non-farm payrolls number has boosted the two-year yield another six basis points, as I write this.
I don’t profess to be an expert on the machinations at the Fed or anything else for that matter.
But anyone who’s been through a stock market bubble/crash or two and even has a vague understanding of economic cycles knows that gravity needs time to finish its work.
While it’s true that, in early 2019, rookie Fed Chairman Jay Powell pivoted from a three-year rate hiking cycle by acquiescing to the bond market, which was calling for rate cuts, and gave in to the stock market, which was tanking, and stopped raising rates.
The crucial difference between 2019 and today is that back then Powell was secure in the knowledge that inflation was benign.
The Fed pivot crowd’s theory now is that Powell will eventually get spooked by how much damage the central bank’s rate increases are inflicting on the economy.
But Powell has made it very clear, as have Fed governors in their recent comments, that inflation is still too hot and could do far worse damage to the economy if they don’t keep raising rates.
Former Federal Reserve Chairman Paul Volcker in 1986
Powell has also given the impression he’s more than willing to emulate legendary former Fed Chairman Paul Volcker, who famously slayed 18 per cent inflation in the early to mid-1980s with a relentless rate hiking cycle that had the central bank’s key rate peaking at nearly 20 per cent.
Volcker induced two recessions, one of them 16 months long, and nearly 11 per cent unemployment in the process but the job was done.
The “Volcker Shock” policy ushered in a multi-decade period where U.S. inflation never went higher than five per cent…until this year.
It can easily be argued that Powell and his crew have made a series of mistakes, which have caused the current inflation problem.
The Fed kept monetary policy too loose for too long and helped to create the epic everything asset bubble that peaked in the fall of last year.
The central bank then parroted the word “transitory” ad nauseam to describe inflation.
That turned out be as wrong as wrong can be.
Now, Powell is trying to clean up the Fed’s mess.
To believe that the same Fed bunch that made those errors will get it right this time is a stretch.
But Powell seems determined to stay the course with ever higher interest rates to get inflation back to the Fed’s target of two per cent, which the central bank predicts will happen by 2025.
In the meantime, gravity, in the form of slowing global economic growth and declining corporate earnings, will continue its inexorable march downward until all of the excesses of the previous go-go cycle are wrung out.
Third quarter earnings season begins next week with analysts having cut their earnings estimates by more than six per cent since the start of the quarter.
Set against inflation, real earnings growth has been negative for a record 17 consecutive months, according to Hedgeye Risk Management.
Odds are good that streak will hit 20 months once the Q3 earnings numbers are in.
That’s as corporations continually issue news that business has slowed down dramatically from the heady days of the third quarter of 2021.
Peloton, one of the pandemic bubble darlings, is one of the latest examples of that issuing another round of job cuts combined with the CEO’s warning about the stationary bike maker’s very survival.
Hedgeye’s growth, inflation and policy (GIP) model has the majority of Western economies in the midst of the second of four consecutive quarters of Quad 4 i.e. slowing growth and slowing inflation.
Another data point of note from Hedgeye is that, historically, inflation cycles when measured from peak to trough last an average of 24 months.
At this point, inflation has only fallen for three months in a row.
Hedgeye CEO Keith McCullough, never shy with his opinions, says the Fed pivot narrative is bullshit.
But many investors appear desperate for the Fed to go dovish and for stocks to find a bottom and go back up.
Even if the Fed did stop raising rates today and then paused or started cutting rates it wouldn’t mean the worst is over for stocks.
In the fall of 2008, post the Lehman Brothers collapse, the Fed and other central banks mounted a coordinated effort by drastically slashing interest rates to virtually zero per cent.
But stocks kept falling and didn’t bottom until March 2009.
Image courtesy Forbes
Similarly, in 2001, in the wake of the tech bubble bursting, the Fed cut its key rate 11 times from six per cent to 1.75%.
The Nasdaq still didn’t bottom until September of 2002.
People hoping for a Fed pivot can push that narrative as much as they want but gravity will eventually win.