Fed Set to Ignore Bond Market Signal

Cheerleading Equities Shouldn't Be Central Bank’s Commission!

The past week provided further signs that the economy is strong, and that inflation is far from dead. And while yesterday’s jobs numbers were weak due to distortions stemming from two hurricanes and the Boeing workers’ strike, wage increases remain at levels too elevated to achieve the Federal Reserve’s inflation target. How will the Fed respond to these developments? Most likely, follow up on the jumbo 50 basis point rate cut of September 18 with another reduction next Thursday. The pretext would be that the latest jobs figure demanded prompt Fed action.

First, let us go over the major data releases last week. On the price front, the Fed’s favorite inflation measure, the Personal Consumption Expenditure index, accelerated on a month-on-month basis in terms of the headline as well as the core calculation. (The latter measure excludes food and fuel.) The same set of calculations indicated that personal consumption spending growth was 0.5% in September, speeding up from 0.3% in August — another indication that inflation is likely to remain a problem in future months.

On the growth front, the US Bureau of Economic Analysis’ first estimate of gross domestic product growth in the third quarter was 2.8%, suggesting continued expansion. And the Federal Reserve Bank of Atlanta’s GDPNow signaled that growth is continuing, estimated at 2.3% for the current quarter as of yesterday. Not too shabby!

Perhaps the jobs numbers would provide support for the shift in focus from inflation to employment that Federal Reserve Chairman Jerome Powell had explained at his press conference last month? Not judging by the ADP numbers for private sector job creation that came out at 233,000 in October, the most since July 2023. And initial jobless claims for the latest week ending October 26 came out at 216,000, falling 12,000 from the previous week. This early indicator of potential labor market problems suggests that layoffs are not a major macroeconomic issue. The resilience showed, again, that the jobs market does not need the stimulus that Powell told us he needs to provide.

The week’s most eagerly sought statistic was yesterday’s nonfarm payrolls coming at only 12,000 jobs for October. Weather- and strike-related distortions were not the only problem with the data. Participation by firms in the survey was extraordinary low, further reducing the predictive power of the statistics. Yet, the numbers showed that the unemployment rate stayed at a relatively low 4.1% last month, and that the labor force participation rate, while down a bit, was still a respectable 62.6%. A warning signal, on the other hand, came from the acceleration in the annual figure for average hourly earnings from 3.9% to 4%.

How will the Federal Open Market Committee react to these developments when it meets November 6 and 7? Don’t expect a mea culpa for having lowered the rate big time. The Fed does not admit to making errors, or apologize. Instead, the FOMC will likely lower the rate by another 25bp, claiming that the labor market needs central bank assistance while inflation is about totally conquered.

In this context, a crucial verdict came from the Treasury market. Yield on 10-year Treasurys sank from 4.32% just before the release of employment numbers yesterday at 8:30 am Eastern time, to 4.23% in the following minutes. As bond investors realized that the small job creation number was illusory and not a measure of labor market weakness, 10-year yield surged to finish the day at 4.40% — up 17bp from the low point of the day.

Bonds are indicating that the continuation of large fiscal deficits in a Kamala Harris or Donald Trump presidency, and the lack of discipline in monetary policy, warrant a much higher yield.

The Federal Reserve can ignore the signal at its own peril.

Dr. Komal Sri-Kumar

President, Sri-Kumar Global Strategies, Inc.

Santa Monica, California

srikumar@srikumarglobal.com

@SriKGlobal

November 2, 2024

Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.

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