Stocks had a mixed close on Friday as traders mulled the latest inflation figures which showed that it continues to trend toward the Fed’s target. Consumer sentiment was revised upwards by University of Michigan; however, the levels still lag pre-COVID levels.
If by sea. The latest inflation figures, out last Friday, are a continued testament that explosive price growth is receding and getting back to normal. By “normal,” I don’t just mean the Fed’s self-created target, I mean that the recent release was well within the long-run range. Good on that. With that out of the way the Fed can focus on normalizing rates before the economy falls into a slump. In recent months economic numbers have flashed mixed signals on economic growth. GDP appears to be resilient… or at least was resilient in the second quarter. The third quarter ends today and we won’t get a reading on Q3 GDP until the end of October. Sentiment is weak but also holding up, despite a recent sharp pullback.
The Fed Funds Rate target is currently 5% after the Bank’s recent -50 basis-point cut. This morning’s futures predict a 40% chance of another -50 basis-point cut in November. That would be considered not-probable in Wall Street terms. Obviously, that number can and will change many times in the next few weeks leading up to the meeting. The important thing to remember is that, despite what was a surprisingly big move from the Fed, rates are still restrictive. The brakes are still engaged, just less than a month ago. The Fed is not expecting its last move to be stimulative in any way, just less restrictive. You may wonder, with inflation mostly licked, why doesn’t the Fed just simply go straight to the neutral rates (aka r-star, or r*). Well, first of all, nobody knows what that rate actually is, so, in essence, the Fed is just going to have to feel its way there. Second, inflation is still above the Fed’s target. Technically, the Core PCE Deflator is still +0.7% higher than the target. It’s getting close, but it’s not there yet. With that, FOMC members are still concerned that inflation could bounce back if they act too quickly. On the other hand, there has been a noticeable increase in the unemployment rate with hints that the labor market is, indeed, slowing more broadly. This places continued pressure on the Fed to weigh its fear that inflation will come back against the potential for a spike in unemployment, which is a key ingredient for a recession.
Well, this week is employment week, rich with economic releases on the topic. Tomorrow, we will get JOLTS Job Openings which has shown a steady but slight decline in job vacancies. On Friday, we will get the official monthly job numbers from the Bureau of Labor Statistics which is expected to show no change over last months 4.3% Unemployment Rate. The Fed, based on its most recent forecast, is expecting that number to end the year slightly higher at 4.4%. Any number above that is likely to illicit a volatile market response. Sure, a higher number could solidify a more aggressive cut in November, but as I have been writing a lot, the markets are now less obsessed with rate cuts but rather more with economic health. In between tomorrow’s JOLTS number and Friday’s big release we will get a private sector employment read from ADP on Wednesday, and the weekly employment numbers on Thursday, so there is lots of fodder for traders to chew on.
So, this week’s strategy is to simply focus on the labor market and how the capital markets respond to releases, right? I am sorry, I wish it would be that simple. I have something else on my radar which is now just a little blip in the outer most ring. Do you remember what sparked this last wave of inflation? Generally, we can blame it on the pandemic, but more specifically it was the supply chain disruptions that really started the whole mess. Stopping, starting, stopping, and starting again not only disrupted production from shuttered manufacturing, but also shipping. Do you remember pictures of piled-high empty shipping containers sitting on the wrong side of the Pacific. How about half-empty freighters steaming about the seas? The cost of shipping containers rose by some +400% from the start of the pandemic through 2022 before finally declining back to pre-pandemic rates in 2023. Earlier this year shipping rates jumped once again, principally due to disruptions in the Gulf region and bad weather in the Pacific, but they appear to be normalizing once again.
Before I go any further, I want to make sure that you agree that increased shipping costs can be a problem for inflation. Remember back in the early days of inflation when you were forced to buy a more expensive model of something or other because stock was depleted. Do you remember suppliers blaming “supply chain problems” for price hikes? Come on, of course you do. Rational companies will not bear sustained supply inflation for too long and will eventually pass those cost increases on to consumers. And yes, cost increases that will find their way into retail prices include shipping costs, so the sooner shipping costs normalize once again, you better believe that the Fed has its eye still firmly on inflation. That said, an as yet little covered story in the financial news is a pending strike by the International Longshoreman’s Association (ILA) union as they work to renegotiate with the US Maritime Alliance, which runs the ports. Check out this cool map I plotted on my Bloomberg and then follow me to the close.
This map shows all the US’s East Coast Ports (green dots). The Longshoremen are the folks responsible for receiving and unloading all the cargo that comes into those ports. That’s a lot of dots, which means a lot of goods coming and going. Imagine the cost of all those Longshoremen going on strike, literally shutting down all those ports. Now, this didn’t pop up overnight, so some companies have already been re-routing cargo to West Coast ports adding trucks and trains to get the cargo where it is needed. I know you’re thinking “that can’t be cheap,” and it isn’t. Hopefully, a strike can be averted. If not, the longer the duration of strike the more likely it is to… disrupt the supply chain once again. Remember what happened the last time the supply chain was disrupted? I don’t know about you, but I am watching this very closely. As mentioned above things are moving in the right direction for normalization, but that thesis is still quite fragile and it can easily be scuttled. The Fed will notice it, the market will notice it, so you should pay attention to it 😊.
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