Stocks climbed. Tariffs hit. Jobs fell. Stocks climbed even more. Here’s why the market still sees a Fed rescue coming.
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On the other hand. President Harry Truman famously said "Give me a one-handed economist! All my economists say, 'on the one hand... on the other hand.’” Truman was, of course, referring to the fact that economists will rarely give you a direct and simple answer. Being of the economist-ilk, I cannot completely disagree with him. However, I would posit that it is not economists but rather the economic data that is to blame, as it rarely illuminates a clear path.
Yesterday’s session was an interesting one containing many mixed signals. I will start with the most important signal: market performance. Stocks traded higher for most of the session and longer-maturity bonds climbed. If we ended with that, we would have said that yesterday was a bullish-leaning, positive day. But really, what was the catalyst or catalysts for that.
I will try to give it to you in a few charts and keep it as simple as possible, as I need to jet out to Yahoo Finance’s studios to guest host their livestreamed Catalysts program with Madison Mills. You should watch it; we have some great guests scheduled and will be covering some interesting topics. Shameless promotion aside, let’s dig in.
I will start by setting the stage. Tariffs. That’s it. Tariffs and the discussion around them is a big overhang when it comes to the markets. Rightly so, as they can cause all sorts of pain to companies–you know the entities behind the stocks that make or break our retirement accounts. Tariffs and the ongoing global brinkmanship driving trade negotiations has been topic No. 1 driving the markets since the President took office in late January. Earnings season came and went (except for a few notable stragglers) with a generally positive result. The S&P and Nasdaq are positive for the year, while the Dow is slightly negative, and the small caps in the red by almost -6%. The S&P is around -10 below its all-time high, feeling like it wants to try to reach the summit. After all, the S&P suffered a nearly -20% drawdown earlier this year, staging a stellar comeback in its wake. So, what gives.
Did you notice something peculiar in that summary? That’s right, no Fed. The Fed, which dominated the dreams and nightmares of traders since… well, forever, especially since 2008. It propped up markets and nearly killed them, leaving them for dead in 2022 and 2023. In 2024, the bankers mysteriously changed its behavior, loosening up on its economic restraints, but it wouldn’t last. The bankers left town once President Trump came back to town, only making a guest appearance in the news cycle here and there. Let’s be clear, the Fed is still super relevant to the economy and the markets. The Fed is sitting on its largest pile of dry powder since before the global financial crisis. I am referring to its ability to lower rates and stimulate the economy. The Fed has a simple job with only two primary objectives: promote maximum employment and stable prices. That’s it! The Fed Funds rate is currently at 4.5% and considered restrictive by most measures. Ready for the charts? Have a look.
This chart shows ADP Monthly Job Additions (white line), which came out yesterday morning. It showed 37k new jobs created last month--way off the expected 114k, and far lower than last month’s downward revised 60k hires. If you looked really closely at the chart, you would notice that not only did the goods producing aggregate not add jobs last month, but it declined marginally. That only happened one other time in the past three years. I am sure that you can spot the negative trend since last year. This coming Friday we will get the “official” new jobs tally from the Bureau of Labor Statistics. While the ADP number has not historically been a good predictor of the more important BLS number, it has been directionally correct more recently (the BLS number is the purple line). This is a negative data point for employment, no matter how you look at it. Hmm, it seems possible that this might be something the Fed would be interested in as labor health occupies 50% of its mandate.
What about stable prices, the other 50%? Have a look at the next chart and keep reading.
This chart shows the Personal Consumption Expenditures (PCE) Price Index. It is one of the Fed’s favorite data series… for obvious reasons. The headline inflation figure (white) line has clearly been in a downward trend and came in last Friday at 2.1%, just above the Fed’s highly publicized target. The core number (light blue line) which excludes energy and food is slightly higher but trending in the same direction. That should be good news for the inflation-fighting Fed. But alas, there is… another hand. That hand is the President’s relentless pursuit of tariffs! Tariffs are unarguably inflationary in the near term as importers pass a portion of their increased costs to consumers. Yet another hand asserts that price rises may only be temporary and not the sticky stuff that got us into this mess. The sticky stuff was services inflation (rust-red bars), which has been receding, albeit slowly. That would seem to be… well, another hand yet. However, it is clear that inflation has been trending down.
So what might the Fed think about all this? Inflation is trending down, and it has acknowledged this, however the bankers are concerned that sticky inflation may be reignited by the tariffs. It chose a wait-and-see approach. While it has been waiting, consumer sentiment and PMI data has been weakening, possibly indicating a slowdown in GDP growth. The Fed has noticed this but has chosen to label it as soft numbers. The Fed has publicly stated that it would await hard data before taking any action. Privately, however, the Fed is concerned about a potential economic pullback. We learned this by reading the minutes from its last meeting as well as from yesterday’s Beige Book.
So, let’s step back and look at these cards. Employment numbers, which are hard numbers, are showing clear signs of decay. The PCE Index is also a hard number, and it is showing clear signs of cooling off, even with tariffs currently in place. We would have expected to see a spike in durable (purple bar) and non-durable goods inflation (yellow bar), but we have not. In fact, non-durables which include clothing (highly subject to import tariffs) actually deflated last month. Two, only two mandates, and they, according to the latest hard numbers, are being met, supporting a softer approach from the Fed.
And now, your final chart. Check it out then follow me to the close.
This chart shows December Fed Funds Futures. You can see that it shot down yesterday in response to the ADP report. What the numbers really show is that, prior to the number, the market gave a 100% chance of one 25 basis-point cut and a 95% chance of a second by the end of the year. Pretty good odds for 2 cuts. After the number, markets gave that second rate cut a 100% and a 27% chance of yet a third.
This perhaps explains why the market is able to maintain these levels despite the growing negativity in the news cycle along with a fresh steel and aluminum tariff. Because, despite the mounting worry of a weaker employment number and the possibility of a swelling debt mountain, there is a concession prize, and that, my friends, is the Fed. They are about to return to their former status as “market driver.” On the other hand, what if Friday’s number does not show the same decline as the ADP release? Well, we just have to sit on our hands and see.
YESTERDAY’S MARKETS
Stocks had a mixed close yesterday on the heels of some less-than-flattering economic data. ADP jobs data came in weak, ISM services sector data suggests a contraction, and the Beige Book implied fear about economic conditions. Musk continued to shoot torpedoes at the reconciliation bill, and investors are caught in the middle of it all.
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