The Fed is not hiking this year.
There, I said it.
I know markets disagree with this assessment, but I believe it. Warsh put on a show and the markets bought it.
This call is going to look even more bold after Thursday’s jobs report, which is setting up to be red hot because of the World Cup and great weather.
Last Week This Morning
10T: 4.37%
2T: 4.09%
SOFR: 3.64%
Term SOFR: 3.64%
Fed Speeches
Fed Goolsbee: “We've been dealing with an inflation problem that's well above the target and has been going the wrong way.”
Fed Williams: “On the price stability side of our dual mandate, inflation is unquestionably elevated and well above the (FOMC’s) longer-run goal of 2% . . . the current stance of monetary policy is well positioned to do that.”
Fed Kashkari: “In March, I had penciled in one rate cut by the end of the year. In June, I’ve changed that to one rate hike by the end of the year.”
Inflation Up But at Expectations
Another inflation bullet dodged as Core PCE came in as expected, 3.4%. The market exhaled, “At least it wasn’t worse than that.”
Sure, but a year ago it was 2.8%. Heck, it was climbing before Iran.
My argument remains the same – hiking rates won’t help open up the Strait of Hormuz. But there is a non-zero chance that an apex inflation hawk like Warsh (who is also conveniently married to a billionaire and probably not super in touch with needing a job to pay the bills) is willing to hike rates to drive Core PCE from 3% to 2%...even if it means 4mm Americans lose their jobs.
San Francisco Fed Economist Adam Shapiro has a cool interactive graph (Supply vs Demand) that breaks down the underlying components of inflation into three buckets: supply, demand, and ambiguous. Demand (blue) is effectively unchanged over the last two years. Monetary policy affects demand and we already seem to be in a nice state of equilibrium.
“But JP, GDP was just revised up from 1.6% to 2.1%. Demand must be up.”
Sure, GDP was revised up, but for all the wrong reasons. Consumer spending was revised lower, while imports were revised sharply lower. Those tax rebates have been spent and the World Cup spending will fade eventually, so I think there’s a chance consumers weaken from here.
Jobs – Thursday
With markets closed Friday for ‘Merica Day, the jobs report will come out Thursday. Last month’s NFP was 172k, and the consensus forecast this month is 115k. The more important print, Unemployment Rate, is expected to come in at 4.3%. I still can’t figure out why the Unemployment Rate isn’t going down if the new breakeven monthly NFP is 0 jobs. Maybe a task force can figure that out.
NFP may benefit from a World Cup boost to Leisure and Hospitality. Bloomberg’s Anna Wong is forecasting a gain of 200k jobs. If she’s right, I would expect the 2yr Treasury to pop as markets price in more hikes.
The T2 is highly correlated to expected hikes/cuts. Bloomberg has a Fed-speak index - check out how nicely the 2yr Treasury tracks the Fed sentiment. If you can predict what the Fed will say, you can predict the T2 response…oh wait, the Fed just abandoned forward guidance.
I don’t see Warsh changing his tone any time soon. He needs to reiterate his independence and a willingness to do whatever it takes to bring inflation down to 2%. Unlike Powell, he might be willing to endure the Unemployment Rate climbing to 6% if it means inflation goes to 2%. Markets, and we, should not underestimate that possibility.
This is bad news for caps, especially if a strong jobs report adds to the existing inflation pressures. Markets have an 80% probability of one hike before year end, so that’s already baked into cap prices. The real cap killer will be if odds of multiple hikes go up sharply. Right now, there’s a 50% chance Fed Funds is north of 4% in Q1 2027. If that jumps to 80%, cap prices are going up even more.
All this talk about hikes is actually good news for the 10yr Treasury, however. Putting a lid on inflation concerns, plus plunging oil, has the T10 down about 35bps in the last month.
It feels like an eternity ago, but right before the initial attack on Iran, the T10 was 3.95% and oil was $65.
Now that oil is back to $70-ish, can we get back to 4%? Not in the near term, and certainly not if the job market data looks strong on Thursday. But if Iran can settle down and the Fed sends all the right signals, I think the T10 can get below 4.25%.
The Week Ahead
Lots of breaking news on Iran this weekend, so tough to tell where we really stand but obviously that will be the main driver. Then Thursday’s jobs report and then we celebrate the US turning 250!