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The Real Fed Funds is Probably Already Negative

August 9, 2021

Last Week This Morning

  • 10 Year Treasury down to 1.30%
    • German bund unch -0.46%
  • 2 Year Treasury down 2bps to 0.21%
  • LIBOR at 0.095%
  • SOFR at 0.05%
  • We added 943k jobs
  • Unemployment rate dropped to 5.4%
  • Average hourly earnings up 4.0%
  • Manufacturing Index fell to a six-month low
  • The ECB modified its stance on inflation targeting, switching to a 2% target rather than a 2% ceiling
    • This allows for overshooting 2%, but is not quite as dovish as the Fed’s change last year to a 2% average target
  • The $1T infrastructure bill was negotiated over the weekend, but impact on rates should be mild because it won’t require a massive Treasury issuance to fund
  • Congrats to Simone Biles for suiting up and winning the bronze on the beam



The economy added almost a million jobs last month, in no way influenced by enhanced unemployment mercifully coming to an end.  Of those 1mm jobs, 220k were from seasonally adjusted gains in education payrolls, while leisure and hospitality added 380k.  Long-term unemployment (those unemployed for more than 6 months) dropped by 560k – the biggest decline ever.

Overall, the trend is very strong.  It’s been four months since we had the disappointing 269k report.  If the report in early September is close to a million, the Fed could easily make the argument that the goal of “substantial further progress” has been achieved.

The Fed’s annual Jackson Hole Symposium is at the end of this month.  While they usually don’t announce formal policy changes here, they do send signals.  The next Fed meeting is September 22, so there will be another job report and about a million data points to digest before then.

On the flip side, we’re still about 5.7mm jobs short of PC levels, and the effects from the Delta variant probably haven’t shown up yet.  JPM put out a research piece that suggests next month could be very disappointing, potentially as low as 53k.

Source: J.P. Morgan

The labor market will be a key drive of Fed policy over the second half of this year, so each month’s number will take on increasing importance.

In that that same report, JPM also predicted inflation over the next 12 months will be 2.43%, including the current spike.


Fed Funds

Fed Vice Chairman Richard Clarida said if the economy continues to recover at its current pace, “commencing policy normalization in 2023 would… be entirely consistent with our new flexible average inflation targeting framework.”

Big headlines, right? Clarida has to be talking to Powell.  But here’s the thing – guess when Clarida is done at the Fed? January. Everyone at the Fed is real brave when a survey is anonymous or on their way out the door.

He did add that hikes are “certainly not something on the radar screen right now,” but that if the recent trend continues, the labor market objectives, “will have been met by year-end 2022.”

Keep in mind that short term floating rates might already be negative.  Here’s that Wu-Xia Shadow Rate I like, suggesting “real” short term rates are -1.89%.  It would take seven hikes from current levels to just get back to 0%.

That ties out nicely with overall financial conditions, which are the most accommodative they’ve ever been.

Source: Bloomberg Finance, LP

If we can’t make money with rates at negative 2% and financial conditions at the most accommodative ever, we’re in the wrong business.


10 Year Treasury

Bloomberg’s rate team has thrown in the towel on its 2.0% y/e forecast. They now call for a 1.60%-ish finish, with some possibility it touches 2.0%.

They believe QE is keeping the 10T about 0.44% too low, so the fair value of the 10T is closer to 1.75%.

Now that the 1.16% level held, we can treat 1.25% as the new floor.


Week Ahead

Some inflation data and consumer confidence data, but hopefully a calmer week than last week.  This is good news as we begin to transition our third child across the country to San Diego for college.  Even though it’s 2,000 miles away, he hasn’t moved in yet, and we haven’t paid tuition yet, he will still be out of the house before his older sisters who have decided living at home is preferable to their own Chapel Hill apartments.


Click to Open: The Pensford Letter PDF